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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q/A

(Amendment No. 1)





(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2009

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission file number 0-30777





PACIFIC MERCANTILE BANCORP

(Exact name of Registrant as specified in its charter)







|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|California                                                     |  | 33-0898238                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



|                                                         |  |           
|-------------------------------------------------------- |  | ----------
|949 South Coast Drive, Suite 300, Costa Mesa, California |  | 92626     
|(Address of principal executive offices)                 |  | (Zip Code)

(714)
438-2500

(Registrants telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed, since last year)





Indicate by check
mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file
such reports); and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ̈

Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate website, if any, every interactive data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).    Yes   ̈    No   ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller
reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.) (Check one):



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  | x
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  |  ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ̈    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date.

10,434,665 shares of Common Stock as of November 6, 2009









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EXPLANATORY NOTE

Pacific Mercantile Bancorp (PMBC, we or us) is filing this Amendment No. 1 to its Quarterly
Report on Form 10-Q for the period ended September 30, 2009, to restate our unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2009 that were contained in the Form 10-Q that we filed with the
Securities and Exchange Commission on November 9, 2009 (the originally filed Form 10-Q).

The restatement gives
effect to an increase in the allowance for loan losses as of September 30, 2009 that was attributable to a redetermination of the amount of that allowance that gives greater weight to qualitative reserve factors than was given in the earlier
determination of the amount of that allowance. This change in weighting of qualitative reserve factors was based on findings of the Federal Reserve Bank (the FRB) and the California Department of Financial Institutions (the
DFI), reported to us in a letter dated January 13, 2010, that (i) additional weight should have been given to qualitative factors in assessing the adequacy of the allowance for loan losses as of September 30, 2009 and
(ii) based on those qualitative factors the amount of that allowance, as of September 30, 2009, should have been approximately $3.3 million higher, or $20.5 million, rather than $17.2 million, as reported in our originally filed
Form 10-Q for the quarter ended September 30, 2009.

As a result of that regulatory finding, at a January 29, 2010
meeting, the Audit Committee of our Board of Directors concluded that the Companys previously filed unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2009, included in our originally
filed Form 10-Q for the quarter then ended, should be restated. The Audit Committee and members of our executive management discussed these matters with Squar, Milner, Peterson, Miranda & Williamson, LLP, our independent registered public
accounting firm. As a result of that determination, on February 1, 2010, we filed a Current Report on Form 8-K with the SEC to report, pursuant to Item 4.02 thereof, the restatement and a resulting non-reliance on our previously reported
unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2009.

We have
also reassessed the effectiveness of our disclosure controls and procedures and internal controls over financial reporting as of September 30, 2009. Based on that evaluation and due to the restatement of the unaudited consolidated financial
statements as of and for the three and nine months ended September 30, 2009, we concluded that our disclosure controls and procedures were not effective as of September 30, 2009. That conclusion was primarily the result of a review
and a reassessment of, and revisions that we have made, to our policies and procedures for evaluating the adequacy of our allowance for loan losses in light of the finding that greater weight needed to be given to qualitative factors in that
evaluation process.

We also concluded that the under-weighting of qualitative reserve factors in the determination of the
allowance for loan losses at September 30, 2009 constituted a material weakness in our internal control over financial reporting, because it resulted in a material misstatement of the amount of the allowance for loan losses at September 30, 2009.
Accordingly, as described in Item 4 of Part I of this Amendment No. 1 on Form 10-Q/A, we have implemented corrective actions designed to prevent a recurrence of such a misstatement in the future.

The information in this Amendment No. 1 not only restates the unaudited consolidated financial statements that were contained in the
originally filed Form 10-Q for the period ended September 30, 2009, but also amends other information in that Form 10-Q affected by the restatement. Therefore, this Amendment No. 1 should be read together with the originally filed Form 10-Q. On the
other hand, this Amendment No. 1 does not update information or disclosures contained in the originally filed Form 10-Q that were not affected by the restatement. Accordingly, this Amendment No. 1 also should be read in conjunction with subsequent
filings that we make with the Securities and Exchange Commission (the SEC) relating to our financial results for the year ended December 31, 2009, as information in such subsequent filings may update or supersede certain information
contained in this Amendment No. 1.

Based on the foregoing, only the following items of the originally filed Form 10-Q for the
period ended September 30, 2009 have been amended:



| |  |  | Part I  Financial Information:
| | - |  | -------------------------------



| |  |  | Item 1  Financial Statements;
| | - |  | ------------------------------



| |  |  | Item 2  Managements Discussion and Analysis of Financial Condition and Results of Operations; and
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | Item 4  Controls and Procedures.
| | - |  | ---------------------------------

In addition, as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended, new certifications by our principal executive officer and principal financial officer are filed herewith as
Exhibits 31.1, 31.2, 32.1 and 32.2 to this Amendment No.1 on Form 10-Q/A.



i



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PACIFIC MERCANTILE BANCORP

AMENDMENT NO. 1

ON

FORM 10-Q/A

FOR

THE QUARTER ENDED SEPTEMBER 30, 2009

TABLE OF CONTENTS



|                                                                                                            |  |                                                                                                                                     |   |    | 
|----------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------- | - | -- | 
|                                                                                                            |  | Page No.                                                                                                                            |  
|Explanatory Note                                                                                            |  | (i                                                                                                                                  | )
|                                                                                                            | 
|Part I. Financial Information                                                                               |  |                                                                                                                                     |  
|                                                                                                            |  |                                                                                                                                    
|Item 1.                                                                                                     |  | Financial Statements                                                                                                                |   | 1  | 
|                                                                                                            |  |                                                                                                                                    
|                                                                                                            |  | Consolidated Statements of Financial Condition at September 30, 2009 (unaudited) and December 
31, 2008                             |   | 1  | 
|                                                                                                            |  |                                                                                                                                    
|                                                                                                            |  | Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2009 and 2008 (unaudited)                   |   | 2  | 
|                                                                                                            |  |                                                                                                                                    
|                                                                                                            |  | Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months ended September 30,
 2009 and 2008 (unaudited) |   | 3  | 
|                                                                                                            |  |                                                                                                                                    
|                                                                                                            |  | Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2009 and 2008
(unaudited)                             |   | 4  | 
|                                                                                                            |  |                                                                                                                                    
|                                                                                                            |  | Consolidated Statements of Shareholders Equity for the Nine Months ended September 30, 2009 (unaudited)                            |   | 6  | 
|                                                                                                            |  |                                                                                                                                    
|                                                                                                            |  | Notes to Consolidated Financial Statements                                                                                          |   | 7  | 
|                                                                                                            |  |                                                                                                                                    
|Item 2.                                                                                                     |  | Managements Discussion and Analysis of Financial Condition and Results of
Operations                                               |   | 23 | 
|                                                                                                            |  |                                                                                                                                    
|Item 4.                                                                                                     |  | Controls and Procedures                                                                                                             |   | 47 | 
|                                                                                                            |  |                                                                                                                                    
|Item 6                                                                                                      |  | Exhibits                                                                                                                            |   | 47 | 
|                                                                                                            | 
|Signatures                                                                                                  |  | S1                                                                                                                                 |  
|                                                                                                            | 
|Exhibit Index                                                                                               |  | E1                                                                                                                                 |  
|                                                                                                            | 
|Exhibit 31.1  Certification of Chief Executive Officer under Section 302 of the
SarbanesOxley Act of 2002 |  |                                                                                                                                     |  
|                                                                                                            | 
|Exhibit 31.2  Certification of Chief Financial Officer under Section 302 of the
SarbanesOxley Act of 2002 |  |                                                                                                                                     |  
|                                                                                                            | 
|Exhibit 32.1  Certification of Chief Executive Officer under Section 906 of the
SarbanesOxley Act of 2002 |  |                                                                                                                                     |  
|                                                                                                            | 
|Exhibit 32.2  Certification of Chief Financial Officer under Section 906 of the
SarbanesOxley Act of 2002 |  |                                                                                                                                     |  



(ii)



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PART I.  FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands)



|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------- | ----------- | ------------------------- | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                               |             | September 30,2009         |           |   | December 31,2008 |  
|                                                                                                                                               | (Unaudited) |                           |           |   |                 
|                                                                                                                                               |             | (As Restated)(See Note 2) |           |   |                  |  
|ASSETS                                                                                                                                         |             |                           |           |   |                  |   |           |  
|Cash and due from banks                                                                                                                        |             | $                         | 11,051    |   |                  | $ | 16,426    |  
|Interest bearing deposits with financial institutions                                                                                          |             |                           | 79,995    |   |                  |   | 90,707    |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|Cash and cash equivalents                                                                                                                      |             |                           | 91,046    |   |                  |   | 107,133   |  
|Interest-bearing time deposits with financial institutions                                                                                     |             |                           | 16,800    |   |                  |   | 198       |  
|Federal Reserve Bank and Federal Home Loan Bank Stock, at cost                                                                                 |             |                           | 13,603    |   |                  |   | 13,420    |  
|Securities available for sale, at fair value                                                                                                   |             |                           | 116,483   |   |                  |   | 160,945   |  
|Loans held for sale, at lower of cost or market                                                                                                |             |                           | 10,598    |   |                  |   |          |  
|Loans (net of allowances of $20,500 and $15,453, respectively)                                                                                 |             |                           | 814,332   |   |                  |   | 828,041   |  
|Investment in unconsolidated subsidiaries                                                                                                      |             |                           | 682       |   |                  |   | 682       |  
|Other real estate owned                                                                                                                        |             |                           | 13,992    |   |                  |   | 14,008    |  
|Accrued interest receivable                                                                                                                    |             |                           | 4,050     |   |                  |   | 3,834     |  
|Premises and equipment, net                                                                                                                    |             |                           | 1,330     |   |                  |   | 1,140     |  
|Other assets                                                                                                                                   |             |                           | 25,663    |   |                  |   | 34,658    |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|Total Assets                                                                                                                                   |             | $                         | 1,108,579 |   |                  | $ | 1,164,059 |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                           |             |                           |           |   |                  |   |           |  
|                                                                                                                                               |             |                          
|Deposits:                                                                                                                                      |             |                           |           |   |                  |   |           |  
|Noninterest-bearing                                                                                                                            |             | $                         | 179,270   |   |                  | $ | 152,462   |  
|Interest-bearing                                                                                                                               |             |                           | 678,268   |   |                  |   | 669,224   |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|Total deposits                                                                                                                                 |             |                           | 857,538   |   |                  |   | 821,686   |  
|Borrowings                                                                                                                                     |             |                           | 152,000   |   |                  |   | 233,758   |  
|Accrued interest payable                                                                                                                       |             |                           | 1,629     |   |                  |   | 2,850     |  
|Other liabilities                                                                                                                              |             |                           | 5,461     |   |                  |   | 4,006     |  
|Junior subordinated debentures                                                                                                                 |             |                           | 17,527    |   |                  |   | 17,527    |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|Total liabilities                                                                                                                              |             |                           | 1,034,155 |   |                  |   | 1,079,827 |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|                                                                                                                                               |             |                          
|Commitments and Contingencies (Note 3)                                                                                                         |             |                           |           |   |                  |   |           |  
|                                                                                                                                               |             |                          
|Shareholders equity:                                                                                                                          |             |                           |           |   |                  |   |           |  
|Preferred stock, no par value, 2,000,000 shares authorized, none issued                                                                        |             |                           |          |   |                  |   |          |  
|Common stock, no par value, 20,000,000 shares authorized, 10,434,665 shares issued and outstanding at September 30, 2009 and
December 31, 2008 |             |                           | 72,844    |   |                  |   | 72,592    |  
|Retained earnings                                                                                                                              |             |                           | 3,162     |   |                  |   | 12,831    |  
|Accumulated other comprehensive loss                                                                                                           |             |                           | (1,582    | ) |                  |   | (1,191    | )
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|Total shareholders equity                                                                                                                     |             |                           | 74,424    |   |                  |   | 84,232    |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  
|Total liabilities and shareholders equity                                                                                                     |             | $                         | 1,108,579 |   |                  | $ | 1,164,059 |  
|                                                                                                                                               |             |                           |           |   |                  |   |           |  

The accompanying notes are an integral part of these consolidated financial statements.



1



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##### Table of Contents

Part I. Item 1 (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per
share data)

(Unaudited)



|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|---------------------------------------------------------------------- |  | ------------------------------- | ---------- | ------------------------------ | ---- | - | -------------------------- |  | - | ---------- | - |  | - | ---------- | -
|                                                                       |  | Three Months EndedSeptember 30, |            | Nine Months EndedSeptember 30, |     
|                                                                       |  | 2009                            |            |                                | 2008 |   | 2009                       |  |   | 2008       |  
|                                                                       |  | (As Restated) (See Note 2)      |            |                                |      |   | (As Restated) (See Note 2) |  |   |            |  
|Interest income:                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Loans, including fees                                                  |  | $                               | 11,936     |                                |      | $ | 12,456                     |  | $ | 35,529     |   |  | $ | 37,582     |  
|Federal funds sold                                                     |  |                                 |           |                                |      |   | 177                        |  |   |           |   |  |   | 796        |  
|Securities available for sale and stock                                |  |                                 | 814        |                                |      |   | 2,595                      |  |   | 2,912      |   |  |   | 7,877      |  
|Interest-bearing deposits with financial institutions                  |  |                                 | 129        |                                |      |   | 2                          |  |   | 373        |   |  |   | 7          |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Total interest income                                                  |  |                                 | 12,879     |                                |      |   | 15,230                     |  |   | 38,814     |   |  |   | 46,262     |  
|Interest expense:                                                      |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Deposits                                                               |  |                                 | 5,701      |                                |      |   | 5,508                      |  |   | 17,699     |   |  |   | 17,459     |  
|Borrowings                                                             |  |                                 | 1,794      |                                |      |   | 2,738                      |  |   | 5,922      |   |  |   | 8,420      |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Total interest expense                                                 |  |                                 | 7,495      |                                |      |   | 8,246                      |  |   | 23,621     |   |  |   | 25,879     |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Net interest income                                                    |  |                                 | 5,384      |                                |      |   | 6,984                      |  |   | 15,193     |   |  |   | 20,383     |  
|Provision for loan losses                                              |  |                                 | 3,790      |                                |      |   | 1,625                      |  |   | 13,833     |   |  |   | 5,441      |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Net interest income after provision for loan losses                    |  |                                 | 1,594      |                                |      |   | 5,359                      |  |   | 1,360      |   |  |   | 14,942     |  
|Noninterest income                                                     |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Total other-than-temporary impairment of securities                    |  |                                 | (787       | )                              |      |   |                           |  |   | (787       | ) |  |   |           |  
|Portion of losses recognized in other comprehensive loss               |  |                                 | 704        |                                |      |   |                           |  |   | 704        |   |  |   |           |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Net impairment loss recognized in earnings                             |  |                                 | (83        | )                              |      |   |                           |  |   | (83        | ) |  |   |           |  
|Service fees on deposits and other banking services                    |  |                                 | 352        |                                |      |   | 326                        |  |   | 1,101      |   |  |   | 823        |  
|Mortgage banking (including net gains on sales of loans held for sale) |  |                                 | 540        |                                |      |   |                           |  |   | 607        |   |  |   |           |  
|Net gain on sale of securities available for sale                      |  |                                 | 446        |                                |      |   | 127                        |  |   | 2,334      |   |  |   | 1,259      |  
|Net loss on sale of other real estate owned                            |  |                                 | (147       | )                              |      |   |                           |  |   | (145       | ) |  |   | (40        | )
|Other                                                                  |  |                                 | 367        |                                |      |   | 251                        |  |   | 776        |   |  |   | 547        |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Total noninterest income                                               |  |                                 | 1,475      |                                |      |   | 704                        |  |   | 4,590      |   |  |   | 2,589      |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Noninterest expense                                                    |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Salaries and employee benefits                                         |  |                                 | 4,194      |                                |      |   | 3,226                      |  |   | 11,580     |   |  |   | 9,348      |  
|Occupancy                                                              |  |                                 | 682        |                                |      |   | 685                        |  |   | 2,038      |   |  |   | 2,064      |  
|Equipment and furniture                                                |  |                                 | 313        |                                |      |   | 252                        |  |   | 868        |   |  |   | 818        |  
|Data processing                                                        |  |                                 | 276        |                                |      |   | 161                        |  |   | 662        |   |  |   | 511        |  
|Professional fees                                                      |  |                                 | 1,338      |                                |      |   | 249                        |  |   | 2,740      |   |  |   | 831        |  
|Customer expense                                                       |  |                                 | 92         |                                |      |   | 121                        |  |   | 281        |   |  |   | 369        |  
|FDIC expense                                                           |  |                                 | 683        |                                |      |   | 166                        |  |   | 1,933      |   |  |   | 478        |  
|Other real estate owned                                                |  |                                 | 1,170      |                                |      |   | 65                         |  |   | 1,689      |   |  |   | 494        |  
|Other operating expense                                                |  |                                 | 764        |                                |      |   | 641                        |  |   | 2,252      |   |  |   | 2,042      |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Total noninterest expense                                              |  |                                 | 9,512      |                                |      |   | 5,566                      |  |   | 24,043     |   |  |   | 16,955     |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Income (loss) before income taxes                                      |  |                                 | (6,443     | )                              |      |   | 497                        |  |   | (18,093    | ) |  |   | 576        |  
|Income tax provision (benefit)                                         |  |                                 | (2,577     | )                              |      |   | 143                        |  |   | (7,546     | ) |  |   | 51         |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Net income (loss)                                                      |  | $                               | (3,866     | )                              |      | $ | 354                        |  | $ | (10,547    | ) |  | $ | 525        |  
|                                                                       |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Earnings (loss) per share                                              |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Basic                                                                  |  | $                               | (0.37      | )                              |      | $ | 0.03                       |  | $ | (1.01      | ) |  | $ | 0.05       |  
|Diluted                                                                |  |                                 | (0.37      | )                              |      |   | 0.03                       |  |   | (1.01      | ) |  |   | 0.05       |  
|Weighted average number of common shares outstanding:                  |  |                                 |            |                                |      |   |                            |  |   |            |   |  |   |            |  
|Basic                                                                  |  |                                 | 10,434,665 |                                |      |   | 10,475,471                 |  |   | 10,434,665 |   |  |   | 10,481,558 |  
|Diluted                                                                |  |                                 | 10,434,665 |                                |      |   | 10,479,280                 |  |   | 10,434,665 |   |  |   | 10,595,249 |  
|Dividends paid per common share                                        |  | $                               |           |                                |      | $ |                           |  | $ |           |   |  | $ | 0.10       |  

The accompanying notes
are an integral part of these consolidated financial statements.



2



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##### Table of Contents

Part I. Item 1 (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in
thousands)

(Unaudited)



|                                                                                                                     |  |                                 |        |                                |      |   |                           |  |   |         |   |  |   |        |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | ---- | - | ------------------------- |  | - | ------- | - |  | - | ------ | -
|                                                                                                                     |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30, |     
|                                                                                                                     |  | 2009                            |        |                                | 2008 |   | 2009                      |  |   | 2008    |  
|                                                                                                                     |  | (As Restated) (See Note 2)      |        |                                |      |   | (As Restated)(See Note 2) |  |   |         |  
|Net income (loss)                                                                                                    |  | $                               | (3,866 | )                              |      | $ | 354                       |  | $ | (10,547 | ) |  | $ | 525    |  
|Other comprehensive income (loss), net of tax:                                                                       |  |                                 |        |                                |      |   |                           |  |   |         |   |  |   |        |  
|Change in unrealized gain (loss) on securities available for sale, net of tax effect                                 |  |                                 | 140    |                                |      |   | 176                       |  |   | (506    | ) |  |   | (2,649 | )
|Change in net unrealized gain and prior service benefit on supplemental executive retirement plan, net of tax
effect |  |                                 | 7      |                                |      |   | 12                        |  |   | 115     |   |  |   | 35     |  
|                                                                                                                     |  |                                 |        |                                |      |   |                           |  |   |         |   |  |   |        |  
|Total comprehensive income (loss)                                                                                    |  | $                               | (3,719 | )                              |      | $ | 542                       |  | $ | (10,938 | ) |  | $ | (2,089 | )
|                                                                                                                     |  |                                 |        |                                |      |   |                           |  |   |         |   |  |   |        |  

The accompanying notes are an integral part of these consolidated financial statements.



3



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##### Table of Contents

Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)



|                                                                                                   |                           |                                |          |      |  |   |          |  
|-------------------------------------------------------------------------------------------------- | ------------------------- | ------------------------------ | -------- | ---- |  | - | -------- | -
|                                                                                                   |                           | Nine Months EndedSeptember 30, |         
|                                                                                                   | 2009                      |                                |          | 2008 | 
|                                                                                                   | (As Restated)(See Note 2) |                                |          |      | 
|Cash Flows From Operating Activities:                                                              |                           |                                |          |      |  |   |          |  
|Net income (loss)                                                                                  |                           | $                              | (10,547  | )    |  | $ | 525      |  
|Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |                           |                                |          |      |  |   |          |  
|Depreciation and amortization                                                                      |                           |                                | 359      |      |  |   | 486      |  
|Provision for loan losses                                                                          |                           |                                | 13,833   |      |  |   | 5,441    |  
|Net amortization of premium on securities                                                          |                           |                                | 1,104    |      |  |   | 213      |  
|Net gains on sales of securities available for sale                                                |                           |                                | (2,334   | )    |  |   | (1,259   | )
|Mark to market loss adjustment of equity securities                                                |                           |                                |         |      |  |   | 25       |  
|Net gains on sales of mortgage loans held for sale                                                 |                           |                                | (311     | )    |  |   |         |  
|Proceeds from sales of mortgage loans held for sale                                                |                           |                                | 28,874   |      |  |   |         |  
|Originations and purchases of mortgage loans held for sale                                         |                           |                                | (39,058  | )    |  |   |         |  
|Mark to market (gain) adjustment of loans held for sale                                            |                           |                                | (166     | )    |  |   |         |  
|Increase in current taxes receivable                                                               |                           |                                | (2,662   | )    |  |   |         |  
|Net amortization of deferred fees and unearned income on loans                                     |                           |                                | (141     | )    |  |   |         |  
|Net loss on sales of other real estate owned                                                       |                           |                                | 145      |      |  |   | 40       |  
|Write down of other real estate owned                                                              |                           |                                | 1,309    |      |  |   | 260      |  
|Stock-based compensation expense                                                                   |                           |                                | 252      |      |  |   | 466      |  
|Other than temporary impairment of securities                                                      |                           |                                | 83       |      |  |   |         |  
|Changes in operating assets and liabilities:                                                       |                           |                                |          |      |  |   |          |  
|Net (increase) decrease in accrued interest receivable                                             |                           |                                | (216     | )    |  |   | 364      |  
|Net (increase) decrease in other assets and capitalized costs on other real estate owned           |                           |                                | (1,460   | )    |  |   | 673      |  
|Net increase in deferred taxes                                                                     |                           |                                | (6,129   | )    |  |   | (2,693   | )
|Net decrease in accrued interest payable                                                           |                           |                                | (1,221   | )    |  |   | (706     | )
|Net increase in other liabilities                                                                  |                           |                                | 1,650    |      |  |   | 267      |  
|                                                                                                   |                           |                                |          |      |  |   |          |  
|Net cash (used in) provided by operating activities                                                |                           |                                | (16,636  | )    |  |   | 4,102    |  
|Cash Flows From Investing Activities:                                                              |                           |                                |          |      |  |   |          |  
|Net increase in interest-bearing deposits with financial institutions                              |                           |                                | (16,602  | )    |  |   |         |  
|Maturities of and principal payments received for securities available for sale and other stock    |                           |                                | 12,037   |      |  |   | 30,595   |  
|Purchase of securities available for sale and other stock                                          |                           |                                | (136,596 | )    |  |   | (118,453 | )
|Proceeds from sale of securities available for sale and other stock                                |                           |                                | 187,681  |      |  |   | 101,838  |  
|Proceeds from sales of other real estate owned                                                     |                           |                                | 3,160    |      |  |   | 943      |  
|Net increase in loans                                                                              |                           |                                | (2,676   | )    |  |   | (70,897  | )
|Purchases of premises and equipment                                                                |                           |                                | (549     | )    |  |   | (48      | )
|                                                                                                   |                           |                                |          |      |  |   |          |  
|Net cash provided by (used in) in investing activities                                             |                           |                                | 46,455   |      |  |   | (56,022  | )
|Cash Flows From Financing Activities:                                                              |                           |                                |          |      |  |   |          |  
|Net increase in deposits                                                                           |                           |                                | 35,852   |      |  |   | 44,035   |  
|Dividends paid                                                                                     |                           |                                |         |      |  |   | (1,049   | )
|Net cash paid for share buyback                                                                    |                           |                                |         |      |  |   | (353     | )
|Net (decrease) increase in borrowings                                                              |                           |                                | (81,758  | )    |  |   | 39,901   |  
|                                                                                                   |                           |                                |          |      |  |   |          |  
|Net cash (used in) provided by financing activities                                                |                           |                                | (45,906  | )    |  |   | 82,534   |  
|                                                                                                   |                           |                                |          |      |  |   |          |  
|Net (decrease) increase in cash and cash equivalents                                               |                           |                                | (16,087  | )    |  |   | 30,614   |  
|Cash and Cash Equivalents, beginning of period                                                     |                           |                                | 107,133  |      |  |   | 53,732   |  
|                                                                                                   |                           |                                |          |      |  |   |          |  
|Cash and Cash Equivalents, end of period                                                           |                           | $                              | 91,046   |      |  | $ | 84,346   |  
|                                                                                                   |                           |                                |          |      |  |   |          |  

The accompanying notes are an integral part of these consolidated financial statements.



4



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##### Table of Contents

Part I. Item 1 (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)



|                                                                                                                       |  |                                |        |   |      |   |        |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                                                       |  | Nine Months EndedSeptember 30, |       
|                                                                                                                       |  | 2009                           |        |   | 2008 |  
|Supplementary Cash Flow Information:                                                                                   |  |                                |        |   |      |   |        |  
|Cash paid for interest on deposits and other borrowings                                                                |  | $                              | 24,698 |   |      | $ | 26,584 |  
|Cash paid for income taxes                                                                                             |  |                                |       |   |      | $ | 1,520  |  
|                                                                                                                       |  |                               
|Non-Cash Investing Activities:                                                                                         |  |                                |        |   |      |   |        |  
|Net decrease in net unrealized losses and prior year service cost on supplemental employee retirement plan, net of
tax |  | $                              | 115    |   |      | $ | 35     |  
|Net increase in net unrealized losses on securities held for sale, net of tax                                          |  |                                | (506   | ) |      | $ | (2,649 | )
|Transfer into other real estate owned                                                                                  |  |                                | 2,756  |   |      | $ | 6,775  |  
|Securities purchased and not settled                                                                                   |  |                                |       |   |      | $ | 9,877  |  

The accompanying notes
are an integral part of these consolidated financial statements.



5



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##### Table of Contents

Part I. Item 1 (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY

(Amounts in
thousands)

For The Nine Months Ended September 30, 2009

(Unaudited)





|                                                                                   |                 |              |        |                  |        |  |                                            |         |   |       |   |        |   |  |   |         |  
|---------------------------------------------------------------------------------- | --------------- | ------------ | ------ | ---------------- | ------ |  | ------------------------------------------ | ------- | - | ----- | - | ------ | - |  | - | ------- | -
|                                                                                   |                 | Common Stock |        | Retainedearnings |        |  | Accumulatedothercomprehensiveincome (loss) |         |   | Total |  
|                                                                                   | Numberof shares |              | Amount |                  |        | 
|Balance at December 31, 2008                                                       |                 | 10,435       |        | $                | 72,592 |  | $                                          | 12,831  |   |       | $ | (1,191 | ) |  | $ | 84,232  |  
|Cumulative effect of adoption of accounting principle(1)                           |                 |             |        |                  |       |  |                                            | 878     |   |       |   | (878   | ) |  |   |        |  
|Stock based compensation expense                                                   |                 |             |        |                  | 252    |  |                                            |        |   |       |   |       |   |  |   | 252     |  
|Net loss(2)                                                                        |                 |             |        |                  |       |  |                                            | (10,547 | ) |       |   |       |   |  |   | (10,547 | )
|Change in unrealized gain on securities held for sale, net of tax                  |                 |             |        |                  |       |  |                                            |        |   |       |   | 372    |   |  |   | 372     |  
|Change in unrealized expense on supplemental executive retirement plan, net of tax |                 |             |        |                  |       |  |                                            |        |   |       |   | 115    |   |  |   | 115     |  
|                                                                                   |                 |              |        |                  |        |  |                                            |         |   |       |   |        |   |  |   |         |  
|Balance at September 30, 2009(2)                                                   |                 | 10,435       |        | $                | 72,844 |  | $                                          | 3,162   |   |       | $ | (1,582 | ) |  | $ | 74,424  |  
|                                                                                   |                 |              |        |                  |        |  |                                            |         |   |       |   |        |   |  |   |         |  



|(1) | Impact on prior period of adopting ASC 320-10, Recognition and Presentation of Other-Than-Temporary-Impairments.
|--- | ----------------------------------------------------------------------------------------------------------------

|(2) | As restated (See Note 2).
|--- | -------------------------

The
accompanying notes are an integral part of this consolidated financial statement.



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##### Table of Contents

Part I. Item 1. (continued)

PACIFIC MERCANTILE BANCORP AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

1. Nature of Business

Pacific Mercantile Bancorp (PMBC) is a bank holding company which, through its wholly owned subsidiary, Pacific Mercantile Bank (the Bank), is engaged in the commercial banking
business in Southern California. PMBC is registered as a one bank holding company under the United States Bank Holding Company Act of 1956, as amended. The Bank is chartered by the California Department of Financial Institutions (the
DFI) and is a member of and subject to regulation by the Federal Reserve Bank of San Francisco (FRB). In addition, the deposit accounts of the Banks customers are insured by the Federal Deposit Insurance Corporation
(FDIC) up to the maximum amount allowed by law. PMBC and the Bank, together, shall sometimes be referred to in this report as the Company or as we, us or our.

Substantially all of our operations are conducted and substantially all our assets are owned by the Bank, which accounts for substantially
all of our consolidated revenues and expenses, and results of operation. The Bank provides a full range of banking services to small and medium-size businesses, professionals and the general public in Orange, Los Angeles, San Bernardino and San
Diego Counties of California and is subject to competition from other financial institutions and from financial services organizations conducting operations in those same markets.

During 2002, we organized three business trusts, under the names Pacific Mercantile Capital Trust I, PMB Capital Trust I, and PMB Statutory
Trust III, respectively, to facilitate our issuance of $5.155 million, $5.155 million and $7.217 million, respectively, principal amount of junior subordinated debentures, all with maturity dates in 2032. In October 2004, we organized PMB Capital
Trust III to facilitate our issuance of an additional $10 million principal amount of junior subordinated debentures, with a maturity date in 2034. The financial statements of these trusts are not included in the Companys consolidated
financial statements. In July 2007, we redeemed the $5.155 million principal amount of junior subordinated debentures issued in conjunction with the organization of Pacific Mercantile Capital Trust I and in August 2007, we redeemed the $5.155
million principal amount of junior subordinated debentures issued in conjunction with the organization of PMB Capital Trust I. Those trusts were dissolved as a result of those redemptions.

2. Restatement of Previously Issued Financial Statements

We have restated our unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2009. The allowance for loan losses and provision for loan losses were
increased to give effect to a greater weighting to qualitative reserve factors by the Bank as part of a redetermination of its allowance for loan losses as of September 30, 2009. This change in weighting of qualitative reserve factors was based
on findings of FRB and DPFI, reported to us in a letter dated January 13, 2010, that additional weight should have been given to qualitative factors in assessing the adequacy of the allowance for loan losses as of September 30, 2009. As a
result of these findings, we concluded that the allowance for loan losses as of September 30, 2009 should be increased, by approximately $3.3 million, to $20.5 million.



|                                              |                |                    |           |            |  |   |             |   |  |   |           |  
|--------------------------------------------- | -------------- | ------------------ | --------- | ---------- |  | - | ----------- | - |  | - | --------- | -
|                                              |                | September 30, 2009 |          
|                                              | As Reported    |                    |           | Adjustment |  |   | As Restated |  
|                                              | (In thousands) |                   
|Consolidated Statement of Financial Condition |                |                    |           |            |  |   |             |   |  |   |           |  
|Assets                                        |                |                    |           |            |  |   |             |   |  |   |           |  
|Allowance for loan losses                     |                | $                  | (17,180   | )          |  | $ | (3,320      | ) |  | $ | (20,500   | )
|Loans, net of allowance for loan losses       |                |                    | 817,652   |            |  |   | (3,320      | ) |  |   | 814,332   |  
|Other Assets                                  |                |                    | 24,297    |            |  |   | 1,366       |   |  |   | 25,663    |  
|Total Assets                                  |                |                    | 1,110,533 |            |  |   | (1,954      | ) |  |   | 1,108,579 |  
|Liabilities and Shareholders Equity          |                |                    |           |            |  |   |             |   |  |   |           |  
|Retained earnings                             |                | $                  | 372       |            |  | $ | (1,954      | ) |  | $ | (1,582    | )
|Total shareholdersequity                     |                |                    | 76,378    |            |  |   | (1,954      | ) |  |   | 74,424    |  
|Total liabilities and shareholders equity    |                |                    | 1,110,533 |            |  |   | (1,954      | ) |  |   | 1,108,579 |  



7



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



2. Restatement of Previously Issued Financial Statements (Cont.-)



|                                                    |                |                                  |        |            |                                 |   |          |   |  |            |        |   |            |   |         |          |  |   |        |   |  |   |         |  
|--------------------------------------------------- | -------------- | -------------------------------- | ------ | ---------- | ------------------------------- | - | -------- | - |  | ---------- | ------ | - | ---------- | - | ------- | -------- |  | - | ------ | - |  | - | ------- | -
|                                                    |                | Three Months Ended September 30, |        |            | Nine Months Ended September 30, |  
|                                                    | AsReported     |                                  |        | Adjustment |                                 |   | Restated |   |  | AsReported |        |   | Adjustment |   |         | Restated | 
|                                                    | (In thousands) |                                 
|Consolidated Statement of Operations                |                |                                  |        |            |                                 |   |          |   |  |            |        |   |            |   |         |          |  |   |        |   |  |   |         |  
|Provision for loan losses                           |                | $                                | 470    |            |                                 | $ | 3,320    |   |  | $          | 3,790  |   |            | $ | 10,513  |          |  | $ | 3,320  |   |  | $ | 13,833  |  
|Net interest income after provision for loan losses |                | $                                | 4,914  |            |                                 | $ | (3,320   | ) |  | $          | 1,594  |   |            | $ | 4,680   |          |  | $ | (3,320 | ) |  | $ | 1,360   |  
|Income (loss) before income taxes                   |                | $                                | (3,123 | )          |                                 | $ | (3,320   | ) |  | $          | (6,443 | ) |            | $ | (14,773 | )        |  | $ | (3,320 | ) |  | $ | (18,093 | )
|Income tax provision (benefit)                      |                |                                  | (1,211 | )          |                                 |   | (1,366   | ) |  |            | (2,577 | ) |            |   | (6,180  | )        |  |   | (1,366 | ) |  |   | (7,546  | )
|                                                    |                |                                  |        |            |                                 |   |          |   |  |            |        |   |            |   |         |          |  |   |        |   |  |   |         |  
|Net income (loss)                                   |                | $                                | (1,912 | )          |                                 | $ | (1,954   | ) |  | $          | (3,866 | ) |            | $ | (8,593  | )        |  | $ | (1,954 | ) |  | $ | (10,547 | )
|                                                    |                |                                  |        |            |                                 |  
|Earnings (loss) per basic and diluted share         |                | $                                | (0.18  | )          |                                 | $ | (0.19    | ) |  | $          | (0.37  | ) |            | $ | (0.82   | )        |  | $ | (0.19  | ) |  | $ | (1.01   | )



|                                      |                |                                     |        |            |  |   |          |   |  |   |         |  
|------------------------------------- | -------------- | ----------------------------------- | ------ | ---------- |  | - | -------- | - |  | - | ------- | -
|                                      |                | Nine Months EndedSeptember 30,
2009 |       
|                                      | AsReported     |                                     |        | Adjustment |  |   | Restated |  
|                                      | (In thousands) |                                    
|Consolidated Statement of Cash Flows: |                |                                     |        |            |  |   |          |   |  |   |         |  
|Net income (loss)                     |                | $                                   | (8,593 | )          |  | $ | (1,954   | ) |  | $ | (10,547 | )
|Provision for loan losses             |                | $                                   | 10,513 |            |  | $ | 3,320    |   |  | $ | 13,833  |  
|Net increase in deferred taxes        |                | $                                   | (4,763 | )          |  | $ | (1,366   | ) |  | $ | (6,129  | )



|                                                       |  |                    |         |   |            |   |        |          |  |   |        |  
|------------------------------------------------------ |  | ------------------ | ------- | - | ---------- | - | ------ | -------- |  | - | ------ | -
|                                                       |  | September 30, 2009 |        
|                                                       |  | AsReported         |         |   | Adjustment |   |        | Restated | 
|                                                       |  | (In thousands)     |        
|Capital and Capital Ratios of the Company and the Bank |  |                    |         |   |            |   |        |          |  |   |        |  
|Total Capital to Risk Weighted Assets                  |  |                    |         |   |            |   |        |          |  |   |        |  
|Company Capital Amount                                 |  | $                  | 101,379 |   |            | $ | (2,137 | )        |  | $ | 99,242 |  
|Company Capital Ratio                                  |  |                    | 11.1    | % |            |   | (0.1   | )        |  |   | 11.0   | %
|Bank Capital Amount                                    |  | $                  | 98,140  |   |            | $ | (2,137 | )        |  | $ | 96,003 |  
|Bank Capital Ratio                                     |  |                    | 10.7    | % |            |   |       |          |  |   | 10.7   | %
|Tier I Capital to Risk Weighted Assets                 |  |                    |         |   |            |   |        |          |  |   |        |  
|Company Capital Amount                                 |  | $                  | 89,836  |   |            | $ | (1,954 | )        |  | $ | 87,882 |  
|Company Capital Ratio                                  |  |                    | 9.8     | % |            |   |       |          |  |   | 9.8    | %
|Bank Capital Amount                                    |  | $                  | 86,612  |   |            | $ | (1,954 | )        |  | $ | 84,658 |  
|Bank Capital Ratio                                     |  |                    | 9.5     | % |            |   | (0.1   | )        |  |   | 9.4    | %
|Tier I Capital To Average Assets                       |  |                    |         |   |            |   |        |          |  |   |        |  
|Company Capital Amount                                 |  | $                  | 89,836  |   |            | $ | (1,954 | )        |  | $ | 87,882 |  
|Company Capital Ratio                                  |  |                    | 7.6     | % |            |   | (0.2   | )        |  |   | 7.4    | %
|Bank Capital Amount                                    |  | $                  | 86,612  |   |            | $ | (1,954 | )        |  | $ | 84,658 |  
|Bank Capital Ratio                                     |  |                    | 7.3     | % |            |   | (0.1   | )        |  |   | 7.2    | %

Certain amounts were also
restated in Note 4  Income (Loss) Per Share, Note 7  Income Taxes, Note 8  Fair Value Measurement and Note 10  Loans.

3. Significant Accounting Policies, Recent Accounting Pronouncements, Commitments and Contingencies

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10Q
and, therefore, do not include all footnotes that would be required for a full presentation of financial position, results of operations, changes in cash flows and comprehensive income (loss) in accordance with generally accepted accounting
principles in the United States (GAAP). However, these interim financial statements reflect all adjustments (consisting of normal recurring adjustments and accruals) which, in the opinion of our management, are necessary for a fair
presentation of our financial position as of the end of and our results of operations for the interim periods presented.

These unaudited consolidated financial statements have been prepared on a basis consistent with prior periods, and should be read in conjunction with our audited consolidated financial statements as of and for the year ended
December 31, 2008, and the notes thereto, included in our Annual Report on Form 10K for the year ended December 31, 2008, as filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934.

Our consolidated financial position at September 30, 2009, and the consolidated results of operations for the three and nine month
periods ended September 30, 2009, are not necessarily indicative of what our financial position will be as of December 31, 2009, or of the results of our operations that may be expected for the full year ending December 31, 2009.

Use of Estimates

The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of
certain of our assets, liabilities, and contingencies at the date of the financial statements and the reported amounts of our revenues and expenses during the reporting periods. For the fiscal periods covered by this Report, those estimates related
primarily to our determinations of the allowance for loan losses, the fair value of securities available for sale, loans held for sale and the valuation of deferred tax assets. If circumstances or financial trends on which those estimates were based
were to change in the future or there were to occur any currently unanticipated events affecting the amounts of those estimates, our future financial position or results of operations could differ, possibly materially, from those expected at the
current time.



8



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



3. Significant Accounting Policies, Recent Accounting Pronouncements, Commitments and Contingencies
(Cont.-)



In September, 2009, the Financial Accounting Standards Board (FASB) issued
an update to Accounting Standard Codification 105-10, Generally Accepted Accounting Principles. This standard establishes the FASB Accounting Standard Codification (Codificationor ASC) as the source of
authoritative U.S. Generally Accepted Accounting Principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of
federal securities laws are also sources of authoritative GAAP for SEC companies. The Codification supersedes all then-existing non-SEC accounting and reporting standards. This Statement is effective for financial statements issued for interim and
annual periods ending after September 15, 2009. FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles, which became effective on November 13, 2008, identified the sources of accounting principles and
the framework for selecting the principles used in preparing the financial statements in conformity with GAAP. Statement 162 arranged these sources of GAAP in a hierarchy for users to apply accordingly. The Codification, and all of its content, will
carry the same level of authority, effectively superseding Statement 162. In other words, the GAAP hierarchy is modified to include only two levels of GAAP: authoritative and non-authoritative. As a result, this Statement replaces Statement 162 to
indicate this change to the GAAP hierarchy.

In April, 2009, the FASB issued an update to ASC 820-10, Fair Value Measurements
and Disclosures (ASC 820-10), which relates to the manner in which fair values are to be determined when there is no active market or where the price inputs being used represent distressed sales. It reaffirms the objective of fair value
measurementto reflect how much an asset would be sold for in an orderly transaction under current market conditions, as opposed to a distressed or forced transaction, at the date of the financial statements. Specifically, it reaffirms the need
to use judgment to ascertain if a formerly active market has become inactive and to determine fair values when markets have become inactive. We adopted this guidance effective as of April 1, 2009. However, it has not had a material effect on
our consolidated financial statements.

In April, 2009, the FASB issued ASC 825-10 (ASC 825-10), Interim
Disclosures about Fair Value of Financial Instruments, which enhances consistency in financial reporting by increasing the frequency of fair value disclosures. ASC 825-10 relates to fair value disclosures for any financial instruments that are
not currently reflected on the balance sheet of companies at fair value. Prior to issuing these statements, fair values for these assets and liabilities were only disclosed once a year. These statements now require disclosures on a quarterly basis,
providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. We adopted these statements April 1, 2009 with no material effect on our
consolidated financial statements.

In April, 2009, the FASB issued ASC 320-10 (ASC 320-10), Recognition and
Presentation of Other-Than-Temporary Impairments, which provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities. ASC 320-10 provide greater clarity to
investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. These statements also require increased and more timely
disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. We adopted these statements April 1, 2009 with no material effect on our consolidated financial statements.

In May 2009, the FASB issued ASC 855-10, which established general standards of accounting for and disclosure of events that occur after the
balance sheet date but before financial statements are issued or are available to be issued. In particular, this Statement sets forth 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or
transactions that may occur for potential recognition or disclosure in the financial statements, 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements,
and 3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. In February 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-09, Subsequent Events (Topic 855):
Amendments to Certain Recognition and Disclosure Requirements(ASU 2010-09).Effective for periodic filings with the SEC after February 23, 2010, ASU 2010-09 amended ASC 855-10 to eliminate the requirement that public
companies (SEC filers, as defined) disclose the date through which subsequent events have been evaluated.



9



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



3. Significant Accounting Policies, Recent Accounting Pronouncements, Commitments and Contingencies
(Cont.-)



Commitments and Contingencies

Commitments

To meet the financing needs of our customers in the normal course of business, we are a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of
credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. At September 30, 2009, loan commitments and letters of credit totaled
$204 million and $12 million, respectively. The contractual amount of a credit-related financial instrument such as a commitment to extend credit, a credit-card arrangement or a letter of credit represents the amounts of potential accounting
loss should the commitment be fully drawn upon, the customer were to default, and the value of any existing collateral securing the customers payment obligation become worthless.

As a result, we use the same credit policies in making commitments to extend credit and conditional obligations as we do for on-balance
sheet instruments. Commitments generally have fixed expiration dates; however, since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We
evaluate each customers creditworthiness on a case-by-case basis, using the same credit underwriting standards that are employed in making commercial loans. The amount of collateral obtained, if any, upon an extension of credit is based on
managements credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, real estate and income-producing commercial properties.

Legal Proceedings

James Laliberte, et al. vs. Pacific Mercantile Bank, filed in May 2003 in the California Superior Court for the County of Orange (Case No. 030007092). This lawsuit was initially filed as an individual action by two plaintiffs
for alleged violations by the Bank of the Federal Truth in Lending Act (the TILA). The two plaintiffs subsequently amended their complaint on three occasions, between November 2003 and May 2005, seeking to convert their individual action
into a class action suit and adding additional allegations and seeking rescission of all loans made to the members of the class and damages based on allegations of fraud in the inducement of certain loans, unfair business practices and violations of
TILA. In each case, the Bank filed demurs in which the Bank asserted that the plaintiffs had failed to establish a legal basis for any recovery and in each case the trial court sustained the Banks demurs and dismissed the plaintiffs
lawsuit. Plaintiffs subsequently appealed the trial courts rulings. In January 2007, the appellate court, in a published decision, affirmed the trial courts order dismissing the plaintiffs suit, finding that plaintiffs had no right
to assert class-wide claims of rescission. Plaintiffs then appealed this decision to the U.S. Supreme Court which, in May 2007, denied plaintiffs petition for review, effectively sustaining the appellate courts ruling.

Plaintiffs, abandoning their claims of fraud and unfair business practices on the part of the Bank, then filed a motion with the trial court
for class certification limited to the TILA and certain related statutory claims. Following a hearing, in January 2008 the trial court denied the motion for class certification, finding that plaintiffs had not shown evidence that there were common
questions of law or fact to justify certifying a class and had been unable to introduce any admissible evidence establishing that any statutory violations had occurred during the relevant class period. As a result of the trial courts ruling,
the two named plaintiffs were left only with individual claims for statutory damages under TILA, which would not have been material in amount.

However, in April 2008, plaintiffs filed an appeal of the trial courts denial of their motion for class certification on the claims under TILA and certain other related statutory claims. In April
2009 the appellate court issued an order certifying plaintiffs class action with respect to the TILA claims and remanded the case back to the trial court for further proceedings. As a result, although it has not yet done so, the trial court
may set a trial date to adjudicate those claims. If the plaintiffs were to prevail in such a trial, they could recover damages of up to, but not to exceed, $500,000 and their attorneys fees in an amount that would be determined by the trial
court.

We believe that the Bank has strong defenses to the plaintiffs claims and will prevail at trial. However,
because the trial is likely to be heard before a jury and the outcome of jury trials is inherently uncertain, it is not possible to predict, with any certainty, the ultimate outcome of the lawsuit.

We also are subject to legal actions that arise from time to time in the ordinary course of our business. Currently there are no such
pending legal proceedings that we believe will become material to our financial condition or results of operations.



10



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



4. Income (Loss) Per Share

Basic income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding
for the period. Diluted income (loss) per common share reflects the potential dilution that would occur if stock options or other contracts to issue common stock were exercised or converted into shares of common stock which would share in our
earnings. For the three and nine month periods ended September 30, 2009, stock options to purchase 1,155,244 shares were not considered in computing diluted loss per common share because they were antidilutive. For the three and nine month
periods ended September 30, 2008, stock options to purchase 1,006,644 and 530,943 shares, respectively, were not considered in computing diluted earnings per common shares because they were antidilutive.

The following table illustrates our computation of basic and diluted income (loss) for the three and nine month periods ended
September 30, 2009 and 2008.



|                                                        |                          |                                 |        |                                |  |                          |        |  |      |         |   |  |   |       
|------------------------------------------------------- | ------------------------ | ------------------------------- | ------ | ------------------------------ |  | ------------------------ | ------ |  | ---- | ------- | - |  | - | ------
|(In thousands, except per share data)                   |                          | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                                        | 2009                     |                                 |        | 2008                           |  | 2009                     |        |  | 2008
|                                                        | As Restated (See Note 2) |                                 |        |                                |  | As Restated (See Note 2) |        |  |     
|Net income (loss) available for common shareholders (A) |                          | $                               | (3,866 | )                              |  | $                        | 354    |  | $    | (10,547 | ) |  | $ | 525   
|                                                        |                          |                                 |        |                                |  |                          |        |  |      |         |   |  |   |       
|Weighted average outstanding shares of common stock (B) |                          |                                 | 10,435 |                                |  |                          | 10,475 |  |      | 10,435  |   |  |   | 10,482
|Dilutive effect of employee stock options and warrants  |                          |                                 |       |                                |  |                          | 4      |  |      |        |   |  |   | 113   
|                                                        |                          |                                 |        |                                |  |                          |        |  |      |         |   |  |   |       
|Common stock and common stock equivalents (C)           |                          |                                 | 10,435 |                                |  |                          | 10,479 |  |      | 10,435  |   |  |   | 10,595
|                                                        |                          |                                 |        |                                |  |                          |        |  |      |         |   |  |   |       
|                                                        |                          |                                 |        |                               
|Income (loss) per share:                                |                          |                                 |        |                                |  |                          |        |  |      |         |   |  |   |       
|Basic (A/B)                                             |                          | $                               | (0.37  | )                              |  | $                        | 0.03   |  | $    | (1.01   | ) |  | $ | 0.05  
|Diluted (A/C)                                           |                          |                                 | (0.37  | )                              |  |                          | 0.03   |  |      | (1.01   | ) |  |   | 0.05  

5. Stock-Based Employee
Compensation Plans

We have in effect three equity incentive compensation plans that provide for the grant of equity
incentives to our officers, other key employees and directors: (i) a 1999 Stock Option Plan (the 1999 Plan), which authorized the granting of options to purchase up to a total of 1,248,230 shares of our common stock (which number
has been adjusted for stock splits effectuated subsequent to the Plans adoption), (ii) a 2004 Stock Incentive Plan (the 2004 Plan) which set aside 400,000 shares our common stock for the grant of stock options and rights to
purchase restricted stock (restricted shares); and (iii) a 2008 Equity Incentive Plan (the 2008 Plan), which set aside an additional 400,000 shares of our common stock for the grant of stock options, restricted shares
and stock appreciation rights (SARs). All three Plans have been approved by our shareholders. Options may no longer be granted under the 1999 Plan as the right to grant options under that Plan expired earlier in 2009.

Stock options entitle the recipients to purchase common stock at a price per share that may not be less than 100% of the fair market value
of the Companys shares on the respective grant dates of the stock options. Restricted shares may be granted at such purchase prices and on such other terms, including restrictions and Company repurchase rights, as are fixed by the Compensation
Committee at the time rights to purchase such shares are granted. SARs entitle the recipient to receive a cash payment in an amount equal to the difference between the fair market value of the Companys shares on the date of vesting and a
base price (which, in most cases, will be equal to fair market value of the Companys shares on the date of grant), subject to the right of the Company to make such payment in shares of its common stock at their then fair market
value. Options, restricted shares and SARs may vest immediately or in installments over various periods generally ranging up to five years, subject to the recipients continued employment or service or the achievement of specified performance
goals, as determined by the Compensation Committee at the time it grants the options, the rights to purchase the restricted shares or the SARs. Stock options and SARs may be granted for terms of up to 10 years after the date of grant, but will
terminate sooner upon or shortly after a termination of service occurring prior to the expiration of the term of the option. The Company will become entitled to repurchase any unvested restricted shares, at the same price that was paid for the
shares by the recipient, in the event of a termination of employment or service of the holder of such shares. To date, the Company has not granted any restricted shares or any SARs.



11



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



5. Stock-Based Employee Compensation Plans (Cont.-)



Under ASC 718-10, we (and other public companies in the United States) are required to
recognize, in our financial statements, the fair value of the options or any restricted shares that we grant as compensation cost over their respective service (vesting) periods.

The fair values of the options that were outstanding under the 1999, 2004 and 2008 Plans were estimated as of their respective dates of
grant using the Black-Scholes option-pricing model. For additional information regarding the Companys stock based compensation plans, refer to Note 11Stock-based Compensation Plans in the Notes to Consolidated Financial
Statements included in the Companys Form 10-K for the year ended December 31, 2008.

The following table summarizes
the weighted average assumptions used for grants in the following periods:



|                                                             |      |                                 |      |         |                                |   |      |   |  |         |      |   |  |   |      |  
|------------------------------------------------------------ | ---- | ------------------------------- | ---- | ------- | ------------------------------ | - | ---- | - |  | ------- | ---- | - |  | - | ---- | -
|Assumptions with respect to:                                 |      | Three Months EndedSeptember 30, |      |         | Nine Months EndedSeptember 30, |  
|                                                             | 2009 |                                 |      | 2008(1) |                                |   | 2009 |   |  | 2008(1) |     
|Expected volatility                                          |      |                                 | 34   | %       |                                |   | 30   | % |  |         | 34   | % |  |   | 30   | %
|Risk-free interest rate                                      |      |                                 | 2.41 | %       |                                |   | 3.74 | % |  |         | 2.41 | % |  |   | 3.53 | %
|Expected dividends                                           |      |                                 | 0.26 | %       |                                |   | 0.26 | % |  |         | 0.26 | % |  |   | 0.66 | %
|Expected term (years)                                        |      |                                 | 6.9  |         |                                |   | 6.9  |   |  |         | 6.9  |   |  |   | 6.9  |  
|Weighted average fair value of options granted during period |      | $                               | 1.41 |         |                                | $ | 1.43 |   |  | $       | 1.39 |   |  | $ | 1.84 |  



|(1) | The Company did not grant stock options during the first quarter of 2008.
|--- | -------------------------------------------------------------------------

The following tables summarize the stock option activity under the Companys 1999, 2004 and 2008 Plans during the nine month period ended September 30, 2009 and 2008, respectively.



|                                  |                                   |                                |      |                                        |   |                                   |  |           |                                        |  |   |      
|--------------------------------- | --------------------------------- | ------------------------------ | ---- | -------------------------------------- | - | --------------------------------- |  | --------- | -------------------------------------- |  | - | -----
|                                  |                                   | Nine Months EndedSeptember 30,
|                                  | 2009                              |                                | 2008
|                                  | Number ofShares Subjectto Options |                                |      | Weighted-AverageExercisePricePer Share |   | Number ofShares Subjectto Options |  |           | Weighted-AverageExercisePricePer Share
|OutstandingJanuary 1,            |                                   | 1,137,244                      |      |                                        | $ | 9.31                              |  | 1,133,139 |                                        |  | $ | 9.82 
|Granted                           |                                   | 58,500                         |      |                                        |   | 3.58                              |  | 17,500    |                                        |  |   | 7.53 
|Exercised                         |                                   |                               |      |                                        |   |                                  |  | (66,062   | )                                      |  |   | 5.23 
|Forfeited/Canceled                |                                   | (40,500                        | )    |                                        |   | 10.70                             |  | (25,333   | )                                      |  |   | 13.81
|                                  |                                   |                                |      |                                        |   |                                   |  |           |                                        |  |   |      
|OutstandingSeptember 30,         |                                   | 1,155,244                      |      |                                        |   | 8.97                              |  | 1,059,244 |                                        |  |   | 9.98 
|                                  |                                   |                                |      |                                        |   |                                   |  |           |                                        |  |   |      
|Options ExercisableSeptember 30, |                                   | 930,936                        |      |                                        | $ | 9.58                              |  | 911,180   |                                        |  | $ | 9.36 
|                                  |                                   |                                |      |                                        |   |                                   |  |           |                                        |  |   |      

The aggregate intrinsic values of options exercised during the nine months ended
September 30, 2008 were $225,000 and there were no options exercised during the nine months ended September 30, 2009. The fair values of vested options at September 30, 2009 and 2008, were $272,645 and $482,000, respectively.



|                        |        |                                             |          |                                             |                               |   |                                                  |  |        |  |                                |  |   |      
|----------------------- | ------ | ------------------------------------------- | -------- | ------------------------------------------- | ----------------------------- | - | ------------------------------------------------ |  | ------ |  | ------------------------------ |  | - | -----
|Range of Exercise Price |        | Options Outstanding as ofSeptember 30, 2009 |          | Options Exercisable as ofSeptember 30, 2009
|                        | Vested |                                             | Unvested |                                             | Weighted-AverageExercisePrice |   | Weighted-AverageRemainingContractualLife (Years) |  | Shares |  | Weighted-AverageExercise Price
|$ 3.48  $5.99          |        | 2,295                                       |          | 165,705                                     |                               | $ | 3.72                                             |  | 9.26   |  | 2,295                          |  | $ | 3.48 
|$ 6.00  $9.99          |        | 507,301                                     |          | 10,000                                      |                               |   | 7.32                                             |  | 1.21   |  | 507,301                        |  |   | 7.33 
|$10.00  $12.99         |        | 310,600                                     |          | 1,000                                       |                               |   | 11.23                                            |  | 4.38   |  | 310,600                        |  |   | 11.22
|$13.00  $17.99         |        | 98,140                                      |          | 39,203                                      |                               |   | 15.07                                            |  | 6.09   |  | 98,140                         |  |   | 15.05
|$18.00  $18.84         |        | 12,600                                      |          | 8,400                                       |                               |   | 18.12                                            |  | 6.32   |  | 12,600                         |  |   | 18.12
|                        |        |                                             |          |                                             |                               |   |                                                  |  |        |  |                                |  |   |      
|                        |        | 930,936                                     |          | 224,308                                     |                               | $ | 8.97                                             |  | 3.91   |  | 930,936                        |  | $ | 9.58 
|                        |        |                                             |          |                                             |                               |   |                                                  |  |        |  |                                |  |   |      



12



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



5. Stock-Based Employee Compensation Plans (Cont.-)



The aggregate intrinsic values of options that were outstanding and exercisable under
the Plans at September 30, 2009, and 2008, were zero and $296,000, respectively. A summary of the status of the unvested options as of December 31, 2008, and changes during the nine month period ended September 30, 2009, are set forth
in the following table.



|                               |  |                                   |   |  |                                      |     
|------------------------------ |  | --------------------------------- | - |  | ------------------------------------ | ----
|                               |  | Number ofShares Subjectto Options |   |  | Weighted-AverageGrant DateFair Value
|                               |  |                                  
|Unvested at December 31, 2008  |  | 233,416                           |   |  | $                                    | 3.39
|Granted                        |  | 58,500                            |   |  |                                      | 1.39
|Vested                         |  | (45,808                           | ) |  |                                      | 5.39
|Forfeited/Canceled             |  | (21,800                           | ) |  |                                      | 3.60
|                               |  |                                   |   |  |                                      |     
|Unvested at September 30, 2009 |  | 224,308                           |   |  | $                                    | 2.43
|                               |  |                                   |   |  |                                      |     

The aggregate amounts charged against income in relation to stock-based compensation awards was
$148,000 net of $104,000 in taxes and $274,000 net of $192,000 in taxes for the nine months ended September 30, 2009 and 2008, respectively. The weighted average period over which nonvested awards are expected to be recognized was 1.86 year at
September 30, 2009. The income tax compensation expense at September 30, 2009 related to non-vested stock options is expected to be recognized in the respective amounts set forth in the table below:



|                                                |  |   |    
|----------------------------------------------- |  | - | ---
|Stock Based Compensation Expense (in thousands) |  |  
|Remainder of 2009                               |  | $ | 83 
|For the year ending December 31,                |  |   |    
|2010                                            |  |   | 194
|2011                                            |  |   | 120
|2012                                            |  |   | 61 
|2013                                            |  |   | 38 
|2014                                            |  |   | 4  
|                                                |  |   |    
|Total                                           |  | $ | 500
|                                                |  |   |    

6. Employee Benefit Plan

The Company has established a Supplemental Retirement Plan (SERP) for its Chief Executive Officer. The components of net periodic
benefit cost for the SERP are set forth in the table below:



|                                   |                |                                 |      |                                |      |    |      |   |     |  |   |    
|---------------------------------- | -------------- | ------------------------------- | ---- | ------------------------------ | ---- | -- | ---- | - | --- |  | - | ---
|                                   |                | Three Months EndedSeptember 30, |      | Nine Months EndedSeptember 30,
|                                   | 2009           |                                 | 2008 |                                | 2009 |    | 2008
|                                   | (In thousands)
|Service cost                       |                | $                               | 47   |                                | $    | 46 |      | $ | 140 |  | $ | 138
|Interest cost                      |                |                                 | 30   |                                |      | 28 |      |   | 91  |  |   | 80 
|Expected return on plan assets     |                |                                 |     |                                |      |   |      |   |    |  |   |   
|Amortization of prior service cost |                |                                 | 3    |                                |      | 4  |      |   | 11  |  |   | 11 
|Amortization of net actuarial loss |                |                                 | 7    |                                |      | 16 |      |   | 30  |  |   | 48 
|                                   |                |                                 |      |                                |      |    |      |   |     |  |   |    
|Net periodic SERP cost             |                | $                               | 87   |                                | $    | 94 |      | $ | 272 |  | $ | 277
|                                   |                |                                 |      |                                |      |    |      |   |     |  |   |    



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



7. Income Taxes

The provision for income taxes was a benefit of $2.6 million and an expense of $143,000 for the three months ended September 30, 2009 and 2008, respectively, representing effective tax rates of
41% and 29% during those periods. The provision for income taxes was a benefit of $7.5 million and an expense of $51,000 for the nine months ended September 30, 2009 and 2008, respectively, representing effective tax rates of 42% and 9%
during those periods. The Company applied an estimated annual effective tax rate to the year-to-date pre-tax earnings to derive the provision for income taxes for the three and nine months ended September 30, 2009 and 2008.

We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits. Our deferred tax assets, net of a valuation allowance, totaled $9.6 million and $6.6 million as of September 30, 2009 and
December 31, 2008, respectively. We evaluate our deferred tax assets for recoverability using a consistent approach which considers the relative impact of negative and positive evidence, including our historical profitability and projections of
future taxable income. We are required to establish a valuation allowance for deferred tax assets and record a charge to income or stockholders equity if we determine, based on available evidence at the time the determination is made, that it
is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management-approved business plans and ongoing tax
planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between our projected operating performance, our actual results
and other factors. During the fourth quarter of 2008, we concluded that it was more likely than not that we would not generate sufficient future taxable income in the foreseeable future to realize all of our deferred tax assets. Our conclusion was
based on our consideration of the relative weight of the available evidence, including the rapid deterioration of market and economic conditions, and the uncertainty of future market conditions on our results of operations. As a result, we recorded
a $3.0 million valuation allowance to our deferred tax asset for the portion of the future tax benefit that more likely than not will not be utilized in the future. We did not, however, establish a valuation allowance for the deferred tax asset
amount that is related to unrealized losses recorded through other comprehensive income on our available-for-sale securities. We believe this deferred tax amount is recoverable because we have the intent and ability to hold these securities until
recovery of the unrealized loss amounts.

The Company files income tax returns with the U.S. federal government and the state
of California. As of September 30, 2009 and January 1, 2009, we were subject to examination by the Internal Revenue Service with respect to our U.S. federal tax returns and the Franchise Tax Board for California, for the 2005 to 2007 tax
years. As of September 30, 2009, the 2006 and 2007 tax years were under examination by the state of California. We do not believe there will be any material adverse changes in our unrecognized tax benefits over the next 12 months.

Net operating losses (NOL) on U.S. federal income tax returns may be carried back five years and forward twenty years. NOL on California
state income tax returns maybe carried forward twenty years. The Company filed an amended prior year U.S. federal tax return and carry back the U.S. federal tax net operating loss. The state of California has suspended the net operating carryover
deduction in 2008 and 2009, but corporations may continue to compute and carryover an NOL during the suspension period. Beginning in 2011, California taxpayers may carryback losses for two years and carryforward for twenty years which will conform
to the U.S. tax laws by 2013. The Company expects to have taxable income in future years to offset the California NOL generated in 2008.

Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of tax expense. We did not have any accrued interest or penalties associated with any unrecognized
tax benefits, and no interest expense was recognized during the nine months ended September 30, 2009 and 2008. Our effective tax rate differs from the federal statutory rate primarily due to tax free income on municipal bonds and certain
non-deductible expenses recognized for financial reporting purposes and state taxes.



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



8. Fair Value Measurements

Fair Value Hierarchy. Under ASC 820-10, we group assets and liabilities at fair value in three levels, based on the markets in which
the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:



|        |  |                                                                                                                                                                                                                                                                                                                                                                                   
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Level 1 |  | Valuation is based upon quoted prices for identical instruments traded in active markets.                                                                                                                                                                                                                                                                                         
|        | 
|Level 2 |  | Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based
valuation techniques for which all significant assumptions are observable in the market.                                                                                                      
|        | 
|Level 3 |  | Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of
assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Assets Measured at Fair Value on a Recurring Basis

Investment Securities Available for Sale. Investment securities available-for-sale are recorded at fair value on a recurring basis.
Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows,
adjusted for the securitys credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 investments securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury
securities that are traded by dealers or brokers in active over-the- counter markets and money market funds. Level 2 investment securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt
securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

The following table
shows the recorded amounts of assets measured at fair value on a recurring basis.



|                                                |       |                                     |         |  |         |       |         |   |         |  |   |      
|----------------------------------------------- | ----- | ----------------------------------- | ------- |  | ------- | ----- | ------- | - | ------- |  | - | -----
|                                                |       | At September 30, 2009(in
thousands)
|                                                | Total |                                     | Level 1 |  | Level 2 |       | Level 3
|Assets at Fair Value:                           |       |                                     |         |  |         |       |         |   |         |  |   |      
|Investment securities available for sale        |       | $                                   | 116,483 |  | $       | 2,292 |         | $ | 111,917 |  | $ | 2,274
|Loans held for sale                             |       |                                     |        |  |         |      |         |   |        |  |   |     
|                                                |       |                                     |         |  |         |       |         |   |         |  |   |      
|Total assets at fair value on a recurring basis |       | $                                   | 116,483 |  | $       | 2,292 |         | $ | 111,917 |  | $ | 2,274
|                                                |       |                                     |         |  |         |       |         |   |         |  |   |      

The changes in Level 3 assets measured at fair value
on a recurring basis are summarized in the following table:



|                                                            |  |                                                       |       |  
|----------------------------------------------------------- |  | ----------------------------------------------------- | ----- | -
|                                                            |  | Investment SecuritiesAvailable for Sale(in thousands) |      
|Balance of recurring Level 3 instruments at January 1, 2009 |  | $                                                     | 1,237 |  
|Total gains or losses (realized/unrealized):                |  |                                                       |       |  
|Included in earnings-realized                               |  |                                                       |      |  
|Included in earnings-unrealized(1)                          |  |                                                       | (83   | )
|Included in other comprehensive income                      |  |                                                       | 306   |  
|Purchases, sales, issuances and settlements, net            |  |                                                       |      |  
|Transfers in and/or out of Level 3                          |  |                                                       | 814   |  
|                                                            |  |                                                       |       |  
|Balance of recurring Level 3 assets at September 30, 2009   |  | $                                                     | 2,274 |  
|                                                            |  |                                                       |       |  



|(1) | Amount includes one non-agency collateralized mortgage obligation security that required assessment for other than temporary impairment and is reported as an other than
temporary impairment loss in the noninterest income portion of the statements of operations. See Note 9 for more details.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



8. Fair Value Measurement (Cont-)



Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S.
generally accepted accounting principles. These include assets that are measured at the lower of cost or market or that were recognized at a fair value below cost at the end of the period.

Impaired Loans. ASC 820-10 applies to loans measured for impairment in accordance with ASC 310-10, Accounting by
Creditors for Impairment of a Loan, including impaired loans measured at an observable market price (if available), and at the fair value of the loans collateral (if the loan is collateral dependent). The fair value of an impaired loan is
estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance for possible losses represent loans for
which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired loan at
Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the impaired loan at Level 3.

Foreclosed Assets. Foreclosed assets are adjusted to fair value, less estimated costs to sell, at the time the loans are transferred
to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is determined based upon independent market prices, appraised values of the collateral or
managements estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the foreclosed asset at Level 2. When an appraised value is not
available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we record the foreclosed asset at Level 3.

Information regarding assets measured at fair value on a nonrecurring basis is set forth in the table below.



|                      |                |                       |         |  |         |   |         |   |        |  |   |       
|--------------------- | -------------- | --------------------- | ------- |  | ------- | - | ------- | - | ------ |  | - | ------
|                      |                | At September 30, 2009
|                      | Total          |                       | Level 1 |  | Level 2 |   | Level 3
|                      | (In thousands)
|Assets at Fair Value: |                |                       |         |  |         |   |         |   |        |  |   |       
|Loans(1)              |                | $                     | 61,729  |  | $       |  |         | $ | 14,440 |  | $ | 47,289
|Loans held for sale   |                |                       | 10,598  |  |         |  |         |   |       |  |   | 10,598
|Other assets(2)       |                |                       | 13,992  |  |         |  |         |   | 13,992 |  |   |      
|                      |                |                       |         |  |         |   |         |   |        |  |   |       
|Total(1)              |                | $                     | 86,319  |  | $       |  |         | $ | 28,432 |  | $ | 57,887
|                      |                |                       |         |  |         |   |         |   |        |  |   |       



|(1) | As restated (See Note 2).
|--- | -------------------------

|(2) | Includes foreclosed assets.
|--- | ---------------------------

There were no transfers in or out of level 3 measurements for nonrecurring items during the nine months ended September 30, 2009.

We have elected to use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair
value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as loans held for investment and
certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair value estimates are made at a discrete point in time based on relevant market information and other information about the financial instruments. Because no active market exists for a significant
portion of our financial instruments, fair value estimates are based in large part on judgments we make primarily regarding current economic conditions, risk characteristics of various financial instruments, prepayment rates, and future expected
loss experience. These estimates are subjective in nature and invariably involve some inherent uncertainties. Additionally unexpected changes in events or circumstances can occur that could require us to make changes to our assumptions and which, in
turn, could significantly affect and require us to make changes to our previous estimates of fair value.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



8. Fair Value Measurement (Cont-)



In addition, the fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of existing and anticipated future customer relationships and the value of assets and liabilities that are not considered financial instruments, such as premises and equipment and other
real estate owned.

The following methods and assumptions were used to estimate the fair value of financial instruments.

Cash and Cash Equivalents. The fair value of cash and cash equivalents approximates its carrying value.

Interest-Bearing Deposits with Financial Institutions. The fair values of interest-bearing deposits maturing within ninety days
approximate their carrying values.

Investment Securities Available for Sale. Investment securities available-for-sale
are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation
techniques such as the present value of future cash flows, adjusted for the securitys credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such
as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities,
municipal bonds and corporate debt securities. Securities classified as level 3 include asset-backed securities in less liquid markets.

Federal Home Loan Bank and Federal Reserve Bank Stock. The Bank is a member of the Federal Home Loan Bank (the FHLB) and the Federal Reserve Bank of San Francisco (the FRB).
As members, we are required to own stock of the FHLB and the FRB, the amount of which is based primarily on the level of our borrowings from those institutions. We also have the right to acquire additional shares of stock in either or both of the
FHLB and the FRB; however, to date, we have not done so. The fair values of that stock are equal to their respective carrying amounts, are classified as restricted securities and are periodically evaluated for impairment based on our assessment of
the ultimate recoverability of our investments in that stock. Any cash or stock dividends paid to us on such stock are reported as income.

Loans Held for Sale.Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for
portfolios with similar characteristics. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 3. There were no fair value adjustments related to the $10.6 million of loans held for sale at
September 30, 2009.

Loans. The fair value for loans with variable interest rates is the carrying amount. The fair
value of fixed rate loans is derived by calculating the discounted value of future cash flows expected to be received by the various homogeneous categories of loans. All loans have been adjusted to reflect changes in credit risk.

Impaired Loans. ASC 820-10 applies to loans measured for impairment in accordance with ASC 310-10, Accounting by Creditors for
Impairment of a Loan, including impaired loans measured at an observable market price (if available), and at the fair value of the loans collateral (if the loan is collateral dependent) less selling cost. The fair value of an impaired
loan is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance for possible losses represent
loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. When the fair value of the collateral is based on an observable market price or a current appraised value, we record the impaired
loan at nonrecurring Level 2. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price or a discounted cash flow has
been used to determine the fair value, we record the impaired loan at nonrecurring Level 3.

Foreclosed Assets.
Foreclosed assets are adjusted to the lower of cost or fair value, less estimated costs to sell, at the time the loans are transferred to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value,
less estimated costs to sell. Fair value is determined on the basis of independent market prices, appraised values of the collateral or managements estimation of the value of the collateral. When the fair value of the collateral is based on an
observable market price or a current appraised value, we record the foreclosed asset at nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the
appraised value and there is no observable market price, we record the foreclosed asset at nonrecurring Level 3.

Deposits. The fair value of demand deposits, savings deposits, and money market deposits is defined as the amounts payable on demand at quarter-end. The fair value of fixed maturity certificates of deposit is estimated based on the
discounted value of the future cash flows expected to be paid on the deposits.



17



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



8. Fair Value Measurement (Cont-)



Borrowings. The fair value of borrowings is the carrying amount for those
borrowings that mature on a daily basis. The fair value of term borrowings is derived by calculating the discounted value of future cash flows expected to be paid out by the Company.

Junior subordinated debentures. The fair value of the junior subordinated debentures is defined as the carrying amount. These
securities are variable rate in nature and reprice quarterly.

Commitments to Extend Credit and Standby Letters of
Credit. The fair value of commitments to extend credit and standby letters of credit, are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties
credit standing. These fees were not material in amount either at September 30, 2009 or December 31, 2008.

The
following table sets forth the estimated fair values and related carrying amounts of our financial instruments as September 30, 2009 and December 31, 2008, respectively.



|                                                      |                        |                    |                     |                   |                |         |                     |   |         |  |   |        
|----------------------------------------------------- | ---------------------- | ------------------ | ------------------- | ----------------- | -------------- | ------- | ------------------- | - | ------- |  | - | -------
|                                                      |                        | September 30, 2009 |                     | December 31, 2008
|                                                      | CarryingAmount         |                    | EstimatedFair Value |                   | CarryingAmount |         | EstimatedFair Value
|                                                      | (Dollars in thousands)
|Financial Assets:                                     |                        |                    |                     |                   |                |         |                     |   |         |  |   |        
|Cash and cash equivalents                             |                        | $                  | 91,046              |                   | $              | 91,046  |                     | $ | 107,133 |  | $ | 107,133
|Interest-bearing deposits with financial institutions |                        |                    | 16,800              |                   |                | 16,800  |                     |   | 198     |  |   | 198    
|Federal Reserve Bank and Federal Home Loan Bank stock |                        |                    | 13,603              |                   |                | 13,603  |                     |   | 13,420  |  |   | 13,420 
|Securities available for sale                         |                        |                    | 116,483             |                   |                | 116,483 |                     |   | 160,945 |  |   | 160,945
|Loans held for sale                                   |                        |                    | 10,598              |                   |                | 10,598  |                     |   |        |  |   |       
|Loans, net(1)                                         |                        |                    | 814,332             |                   |                | 803,520 |                     |   | 828,041 |  |   | 821,339
|Financial Liabilities:                                |                        |                    |                     |                   |                |         |                     |   |         |  |   |        
|Noninterest bearing deposits                          |                        |                    | 179,270             |                   |                | 179,270 |                     |   | 152,462 |  |   | 152,462
|Interest-bearing deposits                             |                        |                    | 678,268             |                   |                | 683,119 |                     |   | 669,224 |  |   | 676,010
|Borrowings                                            |                        |                    | 152,000             |                   |                | 153,805 |                     |   | 233,758 |  |   | 239,514
|Junior subordinated debentures                        |                        |                    | 17,527              |                   |                | 17,527  |                     |   | 17,527  |  |   | 17,527 



|(1) | As restated (See Note 2).
|--- | -------------------------

9. Investment
Securities Available For Sale

The following table summarizes the major components of securities available for sale and
compares the amortized cost, estimated fair market values of, and gross unrealized gains and losses on, such securities at September 30, 2009 and December 31, 2008:



|                                                    |                        |                    |                  |                   |   |           |  |               |        |                  |      |   |           |  |   |         |  |   |       |  |   |        |   |  |   |        
|--------------------------------------------------- | ---------------------- | ------------------ | ---------------- | ----------------- | - | --------- |  | ------------- | ------ | ---------------- | ---- | - | --------- |  | - | ------- |  | - | ----- |  | - | ------ | - |  | - | -------
|                                                    |                        | September 30, 2009 |                  | December 31, 2008
|                                                    | AmortizedCost          |                    | Gross Unrealized |                   |   | FairValue |  | AmortizedCost |        | Gross Unrealized |      |   | FairValue
|                                                    |                        | Gain               |                  | Loss              |   |           |  |               | Gain   |                  | Loss |   |          
|                                                    | (Dollars in thousands)
|Securities Available for Sale                       |                        |                    |                  |                   |   |           |  |               |        |                  |      |   |           |  |   |         |  |   |       |  |   |        |   |  |   |        
|U.S. Treasury Securities                            |                        | $                  | 72,843           |                   | $ | 133       |  | $             |       |                  |      | $ | 72,976    |  | $ |        |  | $ |      |  | $ |       |   |  | $ |       
|Mortgage backed securities issued by US Agencies(1) |                        |                    | 12,457           |                   |   | 65        |  |               | (67    | )                |      |   | 12,455    |  |   | 126,065 |  |   | 1,538 |  |   | (471   | ) |  |   | 127,132
|Collateralized mortgage obligations(1)              |                        |                    | 6,829            |                   |   |          |  |               | (43    | )                |      |   | 6,786     |  |   | 425     |  |   | 4     |  |   |       |   |  |   | 429    
|                                                    |                        |                    |                  |                   |   |           |  |               |        |                  |      |   |           |  |   |         |  |   |       |  |   |        |   |  |   |        
|Total government and agencies securities            |                        |                    | 92,129           |                   |   | 198       |  |               | (110   | )                |      |   | 92,217    |  |   | 126,490 |  |   | 1,542 |  |   | (471   | ) |  |   | 127,561
|Municipal securities                                |                        |                    | 14,180           |                   |   | 149       |  |               | (182   | )                |      |   | 14,147    |  |   | 22,895  |  |   | 90    |  |   | (1,523 | ) |  |   | 21,462 
|Mortgage backed securities issued by non agency(1)  |                        |                    | 7,704            |                   |   |          |  |               | (1,337 | )                |      |   | 6,367     |  |   | 10,278  |  |   |      |  |   | (1,340 | ) |  |   | 8,938  
|Asset backed securities(2)                          |                        |                    | 2,737            |                   |   |          |  |               | (1,277 | )                |      |   | 1,460     |  |   | 1,237   |  |   |      |  |   |       |   |  |   | 1,237  
|Mutual funds(3)                                     |                        |                    | 2,292            |                   |   |          |  |               |       |                  |      |   | 2,292     |  |   | 1,747   |  |   |      |  |   |       |   |  |   | 1,747  
|                                                    |                        |                    |                  |                   |   |           |  |               |        |                  |      |   |           |  |   |         |  |   |       |  |   |        |   |  |   |        
|Total securities available for sale                 |                        | $                  | 119,042          |                   | $ | 347       |  | $             | (2,906 | )                |      | $ | 116,483   |  | $ | 162,647 |  | $ | 1,632 |  | $ | (3,334 | ) |  | $ | 160,945
|                                                    |                        |                    |                  |                   |   |           |  |               |        |                  |      |   |           |  |   |         |  |   |       |  |   |        |   |  |   |        



|(1) | Secured by close-end first lien 1-4 family residential mortgages.
|--- | -----------------------------------------------------------------

|(2) | Comprised of a security that represents an interest in a pool of trust preferred securities issued by U.S.-based banks and insurance companies
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Consists of mutual fund investments in close-end first lien 1-4 family residential mortgages.
|--- | ---------------------------------------------------------------------------------------------



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



9. Investment Securities Available for Sale (Cont-)



The amortized cost and estimated fair values of securities available for sale at
September 30, 2009 and December 31, 2008, are shown in the table below by contractual maturities and historical prepayments based on the prior twelve months of principal payments. Expected maturities will differ from contractual maturities
and historical prepayments, particularly with respect to collateralized mortgage obligations, primarily because prepayment rates are affected by changes in conditions in the interest rate market and, therefore, future prepayment rates may differ
from historical prepayment rates.



|                                                    |                 |                                  |        |                                |  |   |                                 |   |  |               |       |   |       |   |        |   |  |   |         |  
|--------------------------------------------------- | --------------- | -------------------------------- | ------ | ------------------------------ |  | - | ------------------------------- | - |  | ------------- | ----- | - | ----- | - | ------ | - |  | - | ------- | -
|(Dollars in thousands)                              |                 | At September 30, 2009Maturing
in |       
|                                                    | One yearor less |                                  |        | Over oneyear throughfive years |  |   | Over fiveyears throughten years |   |  | Over tenYears |       |   | Total |  
|Securities available for sale, amortized cost       |                 | $                                | 78,069 |                                |  | $ | 11,794                          |   |  | $             | 7,586 |   |       | $ | 21,593 |   |  | $ | 119,042 |  
|Securities available for sale, estimated fair value |                 |                                  | 78,040 |                                |  |   | 11,317                          |   |  |               | 6,857 |   |       |   | 20,269 |   |  |   | 116,483 |  
|Weighted average yield                              |                 |                                  | 0.66   | %                              |  |   | 3.78                            | % |  |               | 4.48  | % |       |   | 3.95   | % |  |   | 1.81    | %



|                                                    |                 |                                 |        |                                |  |   |                                 |   |  |               |        |   |       |   |        |   |  |   |         |  
|--------------------------------------------------- | --------------- | ------------------------------- | ------ | ------------------------------ |  | - | ------------------------------- | - |  | ------------- | ------ | - | ----- | - | ------ | - |  | - | ------- | -
|(Dollars in thousands)                              |                 | At December 31, 2008Maturing
in |       
|                                                    | One yearor less |                                 |        | Over oneyear throughfive years |  |   | Over fiveyears throughten years |   |  | Over tenYears |        |   | Total |  
|Securities available for sale, amortized cost       |                 | $                               | 14,666 |                                |  | $ | 47,466                          |   |  | $             | 33,062 |   |       | $ | 67,453 |   |  | $ | 162,647 |  
|Securities available for sale, estimated fair value |                 |                                 | 14,795 |                                |  |   | 48,097                          |   |  |               | 32,257 |   |       |   | 65,796 |   |  |   | 160,945 |  
|Weighted average yield                              |                 |                                 | 4.25   | %                              |  |   | 4.29                            | % |  |               | 4.56   | % |       |   | 4.54   | % |  |   | 4.44    | %

The Company recognized net
gains on sales of securities available for sale of $1,354,000, net of $980,000 taxes on sale proceeds of $188 million in the nine months ended September 30, 2009 and $1,381,000, net of $965,000 of taxes on sale proceeds of $173 million, in
the year ended December 31, 2008.

The table below shows, as of September 30, 2009, the gross unrealized losses and
fair values of our investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.



|                                                            |                     |                                                          |                |                   |   |            |       |                |   |        |            |   |                |   |  |   |        |  |   |        |  
|----------------------------------------------------------- | ------------------- | -------------------------------------------------------- | -------------- | ----------------- | - | ---------- | ----- | -------------- | - | ------ | ---------- | - | -------------- | - |  | - | ------ |  | - | ------ | -
|(Dollars In thousands)                                      |                     | Securities With Unrealized Loss as of September 30, 2009 |               
|                                                            | Less than 12 months |                                                          |                | 12 months or more |   |            | Total |               
|                                                            | Fair Value          |                                                          | UnrealizedLoss |                   |   | Fair Value |       | UnrealizedLoss |   |        | Fair Value |   | UnrealizedLoss |  
|US agencies and mortgage backed securities                  |                     | $                                                        | 1,630          |                   | $ | (19        | )     |                | $ | 4,163  |            | $ | (48            | ) |  | $ | 5,793  |  | $ | (67    | )
|Collateralized mortgage obligations issued by U.S. agencies |                     |                                                          | 6,786          |                   |   | (43        | )     |                |   |       |            |   |               |   |  |   | 6,786  |  |   | (43    | )
|Non-agency collateralized mortgage obligations              |                     |                                                          | 2,677          |                   |   | (78        | )     |                |   | 3,690  |            |   | (1,259         | ) |  |   | 6,367  |  |   | (1,337 | )
|Asset backed securities                                     |                     |                                                          |               |                   |   |           |       |                |   | 1,460  |            |   | (1,277         | ) |  |   | 1,460  |  |   | (1,277 | )
|Municipal securities                                        |                     |                                                          |               |                   |   |           |       |                |   | 4,081  |            |   | (182           | ) |  |   | 4,081  |  |   | (182   | )
|                                                            |                     |                                                          |                |                   |   |            |       |                |   |        |            |   |                |   |  |   |        |  |   |        |  
|Total temporarily impaired securities                       |                     | $                                                        | 11,093         |                   | $ | (140       | )     |                | $ | 13,394 |            | $ | (2,766         | ) |  | $ | 24,487 |  | $ | (2,906 | )
|                                                            |                     |                                                          |                |                   |   |            |       |                |   |        |            |   |                |   |  |   |        |  |   |        |  

Impairment exists when the fair value of the security is less than its cost. The company performs a
quarterly assessment of its securities that have an unrealized loss to determine whether the decline in fair value of these securities below their cost is other-than-temporary.

The Company adopted ASC 321-10 effective April 1, 2009, and recognizes other-than-temporary impairment for its available-for-sale debt
securities. In accordance with ASC 321-10, when there are credit losses associated with an impaired debt security and the Company does not have the intent to sell the security and it is more likely than not that it will not have to sell the security
before recovery of its cost basis, the Company will separate the amount of impairment into the amount that is credit related and the amount related to non-credit factors. The credit-related impairment is recognized in net gain on sale of securities
on the consolidated statements of operations. The non-credit-related impairment is recognized and reflected in Other Comprehensive Income.



19



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



9. Investment Securities Available for Sale (Cont-)



Through the impairment assessment process, the company determined that the investments
discussed below were other-than-temporarily impaired at September 30, 2009. The Company recorded impairment credit losses in earnings on available for sale securities of $83,000 for the three and nine month periods ended September 30,
2009.

Certain of the OTTI amounts were related to credit losses and recognized into earnings, with the remainder recognized
into other comprehensive loss. The table below presents the roll-forward of other-than-temporary impairments where a portion related to other factors was recognized in other comprehensive loss for the three months ended September 30, 2009:



|                                                                                          |                |                                       |      |   |                                                                   |   |        |                                                        |  |   |        |  
|----------------------------------------------------------------------------------------- | -------------- | ------------------------------------- | ---- | - | ----------------------------------------------------------------- | - | ------ | ------------------------------------------------------ |  | - | ------ | -
|                                                                                          |                | Gross Other-Than-TemporaryImpairments |      |   | Other-Than-TemporaryImpairmentsIncluded in OtherComprehensiveLoss |   |        | Net Other-Than-TemporaryImpairmentsIncluded inEarnings | 
|                                                                                          | (In thousands) |                                      
|Balance  July 1, 2009                                                                    |                | $                                     | (74  | ) |                                                                   | $ | (1,079 | )                                                      |  | $ | (1,153 | )
|Additions for credit losses on securities for which an OTTI was not previously recognized |                |                                       | (83  | ) |                                                                   |   | (704   | )                                                      |  |   | (787   | )
|                                                                                          |                |                                       |      |   |                                                                   |   |        |                                                        |  |   |        |  
|Balance  September 30, 2009                                                              |                | $                                     | (157 | ) |                                                                   | $ | (1,783 | )                                                      |  | $ | (1,940 | )
|                                                                                          |                |                                       |      |   |                                                                   |   |        |                                                        |  |   |        |  

Non Agency CMO

The Company identified one non-agency collateralized mortgage obligation security (CUSIP 94982HAK3) that required assessment for OTTI at September 30 2009. This CMO is a Super Senior
Support bond, which was originated in 2005 and issued by Wells Fargo, was rated AAA by Standard & Poors and Aa1 by Moodys, and had a credit support of 2.5% of the total balance at issuance. As of Sept 30 2009, the security
is rated AAA by Standard and Poors and A by Moodys, has a book value of $1.5 million, a fair value of $813 thousand and a mark-to-market (OCI) loss of $704 thousand. The principal collateral of this security is a pool of one-to-four
family, fully amortizing residential first mortgage loans that have a fixed payment for approximately five years after which they become a variable rate loan with annual resets. Credit support at September 30 was approximately 5.13%, however,
delinquencies 60 days and over were approximately 4.3%. Factors considered in the impairment include the rating change of the security, the current level of subordination from other CMO classes, anticipated prepayment rates, cumulative default rates
and the loss severity given a default. The company recognized an $83,000 impairment loss, representing a credit loss, in earnings. The remaining loss on the security was recognized through other comprehensive income. This non credit portion of OTTI
is attributed to external market conditions, primarily the lack of liquidity in these securities and risks of additional declines in the housing market.

Asset Backed Securities

The Company has one asset backed security
in its investment securities available for sale portfolio. The security is a multi-class, cash flow collateralized bond obligation backed by a pool of trust preferred securities issued by a diversified pool of 56 issuers consisting of 45 U.S.
depository institutions and eleven insurance companies at the time of issuance in November 2007. The total size of this security at issuance was $363 million. The security that the Company owns (CUSIP 74042CAE8) is the mezzanine class B piece that
floats with 3 month libor +60 basis points and had a rating of Aa2/AA by Moodys and Fitch at the time of issuance. The Company purchased $3.0 million face value at a price of 95.21 for $2,856,420 in November 2007.

As of September 30, the book value of this security was $2.7 million with a fair value at $1.5 million for an approximate unrealized
loss of $1.2 million. Currently, the security has a Caa1 rating from Moodys and BB rating from Fitch and has experienced $15 million in defaults (4.2% of total current collateral) and $33 million in deferrals (9.2% of total current collateral)
from issuance to September 30 2009. The Company estimates that there is approximately $16.5 million in potential deferrals and defaults (approximately 5% of performing collateral) before a temporary interest shortfall and $97.5 million before
the Company would not receive all of its contractual cash flows. This analysis took into account future default rates of 3.3%, prepayment rates of 1% until maturity, and 15% recovery of future defaults. The Company has not recognized any additional
impairment to this asset back security in the nine months ended September 30, 2009.



20



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



9. Investment Securities Available for Sale (Cont-)





|                                     |                        |                                        |     |                                       |  |      |   |  |      |     |   |  |   |  
|------------------------------------ | ---------------------- | -------------------------------------- | --- | ------------------------------------- |  | ---- | - |  | ---- | --- | - |  | - | -
|Impairment Losses on OTTI Securities |                        | For the three months endedSeptember 30 |     | For the nine months endedSeptember 30
|                                     | (Dollars in thousands)
|                                     | 2009                   |                                        |     | 2008                                  |  | 2009 |   |  | 2008
|Non Agency CMO                       |                        |                                        | (83 | )                                     |  |      |  |  |      | (83 | ) |  |   | 
|                                     |                        |                                        |     |                                       |  |      |   |  |      |     |   |  |   |  
|                                     |                        | $                                      | (83 | )                                     |  | $    |  |  | $    | (83 | ) |  | $ | 
|                                     |                        |                                        |     |                                       |  |      |   |  |      |     |   |  |   |  

As a part of the Companys OTTI assessment,
management considers information available about the performance of the underlying collateral, including credit enhancements, default rates, loss severities, delinquency rates, vintage, as well as rating agency reports and historical prepayment
speeds. As a result, significant judgment is used in the Companys analysis to determine the expected cash flows for its impaired securities. In determining the component of the OTTI related to credit losses, the Company compares the amortized
cost basis of each other-than-temporarily impaired security to the present value of its expected cash flows, discounted using its effective interest rate implicit in the security at the date of acquisition.

The Companys assessment that it has the ability to continue to hold impaired investment securities along with its evaluation of their
future performance, as indicated by the criteria discussed above, provide the basis for it to conclude that the remainder of its impaired securities are not other-than-temporarily impaired. In assessing whether it is more likely than not that the
Company will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, it considers the significance of each investment, the amount of impairment, as well as the Companys liquidity position and
the impact on the Companys capital position. As a result of its analyses, the Company determined at September 30, 2009 that the unrealized losses on its securities portfolio on which impairments have not been recognized are temporary.

10. Loans

The composition of the Companys loan portfolio as of September 30, 2009 and December 31, 2008 is as follows:



|                                              |        |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|--------------------------------------------- | ------ | ------------------ | ------- | ------- | ----------------- | ----- | ------ |  | - | ------- | - |  | ----- | -
|                                              |        | September 30, 2009 |         |         | December 31, 2008 |      
|                                              | Amount |                    |         | Percent |                   |       | Amount |  |   | Percent |  
|Commercial loans                              |        | $                  | 292,757 |         |                   | 35.1  | %      |  | $ | 300,945 |   |  | 35.7  | %
|Commercial real estate loans - owner occupied |        |                    | 181,135 |         |                   | 21.7  | %      |  |   | 174,169 |   |  | 20.6  | %
|Commercial real estate loans - all other      |        |                    | 131,351 |         |                   | 15.7  | %      |  |   | 127,528 |   |  | 15.1  | %
|Residential mortgage loans - multi-family     |        |                    | 103,690 |         |                   | 12.4  | %      |  |   | 100,971 |   |  | 12.0  | %
|Residential mortgage loans - single family    |        |                    | 63,616  |         |                   | 7.6   | %      |  |   | 65,127  |   |  | 7.7   | %
|Construction loans                            |        |                    | 22,880  |         |                   | 2.7   | %      |  |   | 32,528  |   |  | 3.9   | %
|Land development loans                        |        |                    | 31,607  |         |                   | 3.8   | %      |  |   | 33,283  |   |  | 3.9   | %
|Consumer loans                                |        |                    | 8,164   |         |                   | 1.0   | %      |  |   | 9,173   |   |  | 1.1   | %
|                                              |        |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|Gross loans                                   |        |                    | 835,200 |         |                   | 100.0 | %      |  |   | 843,724 |   |  | 100.0 | %
|                                              |        |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|Deferred fee (income) costs, net              |        |                    | (368    | )       |                   |       |        |  |   | (230    | ) |  |       |  
|Allowance for loan losses(1)                  |        |                    | (20,500 | )       |                   |       |        |  |   | (15,453 | ) |  |       |  
|                                              |        |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|Loans, net(1)                                 |        | $                  | 814,332 |         |                   |       |        |  | $ | 828,041 |   |  |       |  
|                                              |        |                    |         |         |                   |       |        |  |   |         |   |  |       |  



|(1) | Restated (See Note 2).
|--- | ----------------------

Changes
in the allowance for loan losses for the nine months ended September 30, 2009 and the year ended December 31, 2008 are as follows:



|                                           |  |                                     |        |   |                             |   |         |  
|------------------------------------------ |  | ----------------------------------- | ------ | - | --------------------------- | - | ------- | -
|                                           |  | Nine Months EndedSeptember 30, 2009 |        |   | Year EndedDecember 31, 2008 |  
|Balance, beginning of period               |  | $                                   | 15,453 |   |                             | $ | 6,126   |  
|Provision for loan losses(1)               |  |                                     | 13,833 |   |                             |   | 21,685  |  
|Recoveries on loans previously charged off |  |                                     | 116    |   |                             |   | 80      |  
|Net, amounts charged off                   |  |                                     | (8,902 | ) |                             |   | (12,438 | )
|                                           |  |                                     |        |   |                             |   |         |  
|Balance, end of period(1)                  |  | $                                   | 20,500 |   |                             | $ | 15,453  |  
|                                           |  |                                     |        |   |                             |   |         |  



|(1) | Restated (See Note 2)
|--- | ---------------------



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.-)



10. Loans (Cont.-)



As of September 30, 2009, the Company had approximately $62.0 million of loans
deemed impaired of which $59.6 million was nonaccrual, $22.3 million of troubled debt restructurings which was comprised of $19.8 million in nonaccrual loans and $2.4 million accruing loans performing in accordance to the modified terms, and $10.9
million of other impaired loans less than 90 days delinquent. As of December 31, 2008, the Company had $30.7 million of loans deemed impaired of which $11 million was nonaccrual, $7.5 million of troubled debt restructurings which was comprised
of $4.9 million in nonaccrual loans and $2.6 million accruing loans performing in accordance to the modified terms, and $12.3 million of loans less than 90 days delinquent.



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##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

Introduction

Pacific Mercantile Bancorp is a bank holding company that owns all of the stock of Pacific Mercantile Bank (the Bank), which is a commercial bank that provides a full range of banking services to small and medium-size businesses
and to professionals and the general public in Orange, Los Angeles, San Bernardino and San Diego counties, in Southern California. Substantially all of our operations are conducted and substantially all of our assets are owned by the Bank, which
accounts for substantially all of our consolidated revenues, expenses and operating income.

The following discussion presents
information about (i) our consolidated results of operations for the three and nine month periods ended September 30, 2009 and comparisons of those results with the results of operations for the corresponding three and nine month periods
of 2008, and (ii) our consolidated financial condition, liquidity and capital resources at September 30, 2009. The information in the following discussion should be read in conjunction with our interim consolidated financial statements and
the notes thereto included elsewhere in this Report.

Forward-Looking Information

Statements contained in this Report that are not historical facts or that discuss our expectations, beliefs or views regarding our future
operations or future financial performance, or financial or other trends in our business or in the markets in which we operate, constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933,
as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include words such as
believe, expect, anticipate, intend, plan, estimate, project, forecast or words of similar meaning, or future or conditional verbs such as
will, would, should, could, or may. The information contained in such forward-looking statements is based on current information and on assumptions that we make about future events over
which we do not have control. In addition, our business and the markets in which we operate are subject to a number of risks and uncertainties. Unexpected future events and such risks and uncertainties could cause our financial condition or actual
operating results in the future to differ significantly from our expected financial condition or operating results that are set forth in the forward looking statements contained in this Report and could, therefore, also affect the price performance
of our shares. Certain of those risks and uncertainties are discussed below in this Item 2 of this Report, in Item 1A in our Annual Report on Form 10-K for our fiscal year ended December 31, 2008 (our 2008 10-K)
and in Item 1A, entitled Risk Factors, in Part II of this Report. Therefore, you are urged to read not only the information contained in this section of this Report, but also the information contained in Item 1A of our
2008 10-K and in Item 1A in Part II of this Report in conjunction with your review of the following discussion regarding our results of operations for the three and nine months ended, and our financial condition at, September 30,
2009.

Due to those risks and uncertainties, readers are cautioned not to place undue reliance on the forward-looking
statements contained in this Report, which speak only as of the date of this Report, or to make predictions about future performance based solely on historical financial performance. We also disclaim any obligation to update forward-looking
statements contained in this Report or in our 2008 10-K or any other of our filings previously made with Securities and Exchange Commission, except as may otherwise be required by law or Nasdaq rules.



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##### Table of Contents

Overview of Operating Results in the Three and Nine Months Ended September 30,
2009

The following table sets forth information regarding the interest income that we generated, the interest expense
that we incurred, our net interest income, noninterest income, noninterest expense, and our net income (loss) and net income (loss) per share for the three and nine month periods set forth below.



|                                                           |                |                                 |            |             |                                |                |            |  |                |    |  |             |            |                |  |   |            |  |       |   
|---------------------------------------------------------- | -------------- | ------------------------------- | ---------- | ----------- | ------------------------------ | -------------- | ---------- |  | -------------- | -- |  | ----------- | ---------- | -------------- |  | - | ---------- |  | ----- | --
|                                                           |                | Three Months EndedSeptember 30, |            |             | Nine Months EndedSeptember 30, |               
|                                                           | 2009Amounts    |                                 |            | 2008Amounts |                                | PercentChange  |            |  | 2009Amounts    |    |  | 2008Amounts |            | PercentChange  | 
|                                                           | As Restated(1) |                                 |            |             |                                | As Restated(1) |            |  | As Restated(1) |    |  |             |            | As Restated(1) | 
|Interest income                                            |                | $                               | 12,879     |             |                                | $              | 15,230     |  | (15.4          | )% |  | $           | 38,814     |                |  | $ | 46,262     |  | (16.1 | )%
|Interest expense                                           |                |                                 | 7,495      |             |                                |                | 8,246      |  | (9.1           | )% |  |             | 23,621     |                |  |   | 25,879     |  | (8.7  | )%
|                                                           |                |                                 |            |             |                                |                |            |  |                |    |  |             |            |                |  |   |            |  |       |   
|Net interest income                                        |                |                                 | 5,384      |             |                                |                | 6,984      |  | (22.9          | )% |  |             | 15,193     |                |  |   | 20,383     |  | (25.5 | )%
|                                                           |                |                                 |            |             |                                |                |            |  |                |    |  |             |            |                |  |   |            |  |       |   
|Provision for loan losses                                  |                |                                 | 3,790      |             |                                |                | 1,625      |  | 133.2          | %  |  |             | 13,833     |                |  |   | 5,441      |  | 154.2 | % 
|                                                           |                |                                 |            |             |                                |                |            |  |                |    |  |             |            |                |  |   |            |  |       |   
|Net interest income (loss) after provision for loan losses |                |                                 | 1,594      |             |                                |                | 5,359      |  | (70.3          | )% |  |             | 1,360      |                |  |   | 14,942     |  | (90.9 | )%
|Noninterest income                                         |                |                                 | 1,475      |             |                                |                | 704        |  | 109.5          | %  |  |             | 4,590      |                |  |   | 2,589      |  | 77.3  | % 
|Noninterest expense                                        |                |                                 | 9,512      |             |                                |                | 5,566      |  | 70.9           | %  |  |             | 24,043     |                |  |   | 16,955     |  | 41.8  | % 
|                                                           |                |                                 |            |             |                                |                |            |  |                |    |  |             |            |                |  |   |            |  |       |   
|Income (loss) before income tax                            |                |                                 | (6,443     | )           |                                |                | 497        |  | N/M            |    |  |             | (18,093    | )              |  |   | 576        |  | N/M   |   
|Income tax (benefit) provision                             |                |                                 | (2,577     | )           |                                |                | 143        |  | N/M            |    |  |             | (7,546     | )              |  |   | 51         |  | N/M   |   
|                                                           |                |                                 |            |             |                                |                |            |  |                |    |  |             |            |                |  |   |            |  |       |   
|Net income (loss)                                          |                | $                               | (3,866     | )           |                                | $              | 354        |  | N/M            |    |  | $           | (10,547    | )              |  | $ | 525        |  | N/M   |   
|Net income (loss) per diluted share                        |                | $                               | (0.37      | )           |                                | $              | 0.03       |  | N/M            |    |  | $           | (1.01      | )              |  | $ | 0.05       |  | N/M   |   
|Weighted average number of diluted shares                  |                |                                 | 10,434,665 |             |                                |                | 10,479,280 |  | N/M            |    |  |             | 10,434,665 |                |  |   | 10,595,249 |  | (1.5  | )%



|(1) | Certain of these amounts and percentages have been restated. See Note 2 to the unaudited Consolidated Financial Statements contained elsewhere in this report.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------

We incurred net losses of $3.9 million, or $0.37 per diluted share, and $10.5 million, or $1.01 per
diluted share, in the three and nine month periods ended September 30, 2009, respectively, as compared to net income of $354,000, or $0.03 per diluted share, and $525,000, or $0.05 per diluted share, in the same three and nine month
periods of 2008, respectively. The net losses in the three and nine months ended September 30, 2009 were primarily attributable to:



| |  |  | Declines in net interest income of $1.6 million, or 22.9%, and $5.2 million, or 25.5%, respectively, in the three and nine month periods ended
September 30, 2009, due primarily to decreases in interest income that were only partially offset by decreases in interest expense, as interest income was adversely affected by (i) reductions in interest rates implemented by the Federal
Reserve Board which affected the yields we were able to realize on loans and other interest-earning assets, and (ii) an increase, during the nine months ended September 30, 2009, of $37.3 million, or 234%, in non-performing loans, on
which we were required to cease accruing interest.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Increases, during the three and nine months ended September 30, 2009, in the provisions we made for loan losses of $2.2 million, or 133%, and
$8.4 million, or 154%, to provide for (i) the increases that occurred in non-performing loans during that period and the risk of possible increases in non-performing loans in future months due to the continuing economic recession and
credit crisis and the prospect that these conditions were not likely to improve significantly during the remainder of 2009. These increases in the provision for loan losses resulted in an increase in the amount of our allowance for loan losses to
$20.5 million, or approximately 2.46% of loans outstanding, at September 30, 2009, as compared to $15.5 million, or 1.83%, of the loans outstanding at December 31, 2008.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Increases in noninterest expense of $3.9 million, or 70.9%, and $7.1 million, or 41.8%, in the three and nine months ended September 30,
2009, respectively, due primarily to (i) the addition of personnel in our credit administration department and for our new mortgage banking business which commenced operations during the second quarter 2009, (ii) increases in expenses
incurred in connection with the collection and foreclosures of non-performing loans and the carrying costs of the properties acquired by foreclosure (Other Real Estate Owned or OREO), and (iii) an increase by the FDIC in
insurance premiums imposed on all FDIC-insured banks as a means of funding increases in the FDICs insurance fund.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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We believe that our actions in charging off nonperforming loans and increasing the allowance
for loan losses were prudent in light of prevailing economic conditions and the uncertainties regarding the ultimate duration and severity of the economic recession and credit crisis.

The following table indicates the impact that the decreases in our net interest income and the net losses incurred in the three and nine
months ended September 30, 2009 have had on our net interest margin and the returns on average assets and average equity during those periods:



|                                          |                |                                 |    |      |                                |   |                |        |    |      |      |  
|----------------------------------------- | -------------- | ------------------------------- | -- | ---- | ------------------------------ | - | -------------- | ------ | -- | ---- | ---- | -
|                                          |                | Three Months EndedSeptember 30, |    |      | Nine Months EndedSeptember 30, |  
|                                          | 2009           |                                 |    | 2008 |                                |   | 2009           |        |    | 2008 |     
|                                          | As Restated(1) |                                 |    |      |                                |   | As Restated(1) |        |    |      |     
|Net interest margin(2) (3)                |                | 1.88                            | %  |      | 2.56                           | % |                | 1.76   | %  |      | 2.52 | %
|Return on average assets(2)               |                | (1.30                           | )% |      | 0.13                           | % |                | (1.18  | )% |      | 0.06 | %
|Return on average shareholders equity(2) |                | (19.86                          | )% |      | 1.51                           | % |                | (16.67 | )% |      | 0.74 | %



|(1) | Certain of these percentages have been restated. See Note 2 to the unaudited Consolidated Financial Statements contained elsewhere in this report.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Annualized.
|--- | -----------

|(3) | Net interest income expressed as a percentage of total average interest earning assets.
|--- | ---------------------------------------------------------------------------------------

At September 30, 2009, non-performing loans, together with other nonperforming assets consisting of OREO, totaled $74 million, or 6.7%
of total assets, as compared to $29.9 million or 2.6% of total assets at December 31, 2008.

Critical Accounting
Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in
the United States (GAAP) and general practices in the banking industry. Certain of those accounting policies are considered critical accounting policies, because they require us to make assumptions and judgments regarding circumstances
or trends that could affect the value of those assets, such as, for example, assumptions regarding economic conditions or trends that could impact our ability to fully collect our loans or ultimately realize the carrying value of certain of our
other assets, such as securities available for sale and our deferred tax assets. Those assumptions and judgments are made based on current information available to us regarding those economic conditions or trends or other circumstances. If adverse
changes were to occur in the events, trends or other circumstances on which our assumptions or judgments had been based, or other unanticipated events were to happen that might affect our operating results, under GAAP it could become necessary for
us to reduce the carrying values of the affected assets on our balance sheet. In addition, because reductions in the carrying value of assets are sometime effectuated by or require charges to income, such reductions also may have the effect of
reducing our income.

For additional information regarding critical accounting policies, refer to Note
3Significant Accounting Policies in the Notes to Consolidated Financial Statements and the sections captioned Critical Accounting Policies and Allowance for Loan Losses in Managements Discussion and
Analysis of Financial Condition and Results of Operations included in the Companys Form 10-K for the year ended December 31, 2008. There have been no significant changes in the Companys application of accounting policies since
December 31, 2008.

Results of Operations

Net Interest Income

One of the principal determinants of a banks income is its net interest income, which is the difference between (i) the interest that a bank earns on loans, investment securities and other interest-earning assets, on the one
hand, and (ii) its interest expense, which consists primarily of the interest it must pay to attract and retain deposits and the interest that it pays on borrowings and other interest-bearing liabilities, on the other hand. As a general rule,
all other things being equal, the greater the difference or spread between the amount of our interest income and the amount of our interest expense, the greater will be our net income; whereas, a decline in that difference or
spread will generally result in a decline in our net income. A banks interest income and interest expense are, in turn, affected by a number of



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##### Table of Contents

factors, some of which are outside of its control, including national and local economic conditions and the monetary policies of the Federal Reserve Board which affect interest rates, competition
in the market place for loans or deposits, the demand for loans and the ability of borrowers to meet their loan payment obligations. Net interest income, when expressed as a percentage of total average interest earning assets, is a banking
organizations net interest margin.

The following table sets forth our interest income, interest expense and
net interest income (in thousands of dollars) and our net interest margin in the three and nine months ended September 30, 2009 and 2008, respectively:



|                    |            |                                 |        |            |                                |   |               |   |  |            |    |  |            |        |   |               |   |        |   |  |       |   
|------------------- | ---------- | ------------------------------- | ------ | ---------- | ------------------------------ | - | ------------- | - |  | ---------- | -- |  | ---------- | ------ | - | ------------- | - | ------ | - |  | ----- | --
|                    |            | Three Months EndedSeptember 30, |        |            | Nine Months EndedSeptember 30, |  
|                    | 2009Amount |                                 |        | 2008Amount |                                |   | PercentChange |   |  | 2009Amount |    |  | 2008Amount |        |   | PercentChange |  
|Interest income     |            | $                               | 12,879 |            |                                | $ | 15,230        |   |  | (15.4      | )% |  | $          | 38,814 |   |               | $ | 46,262 |   |  | (16.1 | )%
|Interest expense    |            |                                 | 7,495  |            |                                |   | 8,246         |   |  | (9.1       | )% |  |            | 23,621 |   |               |   | 25,879 |   |  | (8.7  | )%
|                    |            |                                 |        |            |                                |   |               |   |  |            |    |  |            |        |   |               |   |        |   |  |       |   
|Net interest income |            | $                               | 5,384  |            |                                | $ | 6,984         |   |  | (22.9      | )% |  | $          | 15,193 |   |               | $ | 20,383 |   |  | (25.5 | )%
|                    |            |                                 |        |            |                                |   |               |   |  |            |    |  |            |        |   |               |   |        |   |  |       |   
|Net interest margin |            |                                 | 1.88   | %          |                                |   | 2.56          | % |  |            |    |  |            | 1.76   | % |               |   | 2.52   | % |  |       |   

As the above table indicates, our net interest income decreased by $1.6 million, or 23%, in
the third quarter of 2009, and by $5.2 million, or 26%, in the nine months ended September 30, 2009. The decreases were primarily attributable to decreases in interest income of $2.4 million, or 15%, and $7.4 million, or 16%,
respectively, in those three and nine month periods, which more than offset decreases in interest expense of $751,000, or 9%, and $2.3 million, or about 9%, respectively, in the three and nine months ended September 30, 2009.

Those decreases in interest income were due primarily to (i) declines of 500 basis points in prevailing market rates of interest
primarily as a result of reductions, commenced in September 2007, in the federal funds rate implemented by the Federal Reserve Board in response initially to a slowing in economic growth and, then, to the economic recession and credit crisis, and
(ii) the increases, described above, in non-performing loans, on which we ceased accruing interest income. Those decreases were only partially offset by the effects on interest income of increases, in the three and nine months ended
September 30, 2009, of $29 million and $48 million, respectively, in average loans outstanding, which generate higher yields than other interest earning assets.

The decreases in interest expense during the three and nine month periods ended September 30, 2009 were primarily attributable to the aforementioned decreases in prevailing market rates of interest,
which enabled us to reduce the rates at which we paid interest on substantially all types of interest bearing deposits, including certificates of deposit. However, those decreases in interest expense were partially offset by increases, during the
three and nine months ended September 30, 2009, in the volume of certificates of deposit, on which we pay interest at higher rates than on other types of deposits, as we used those deposits to provide additional funds that enabled us to
increase the volume of the loans we made and to reduce borrowings during the three and nine months ended September 30, 2009.

Primarily as a result of the decreases in interest income in the three and nine months ended September 30, 2009, our net interest margin declined to 1.88% and 1.76%, respectively, from 2.56% and 2.52% in the same three and nine month
periods of 2008. In the three months ended September 30, 2009, the yield on interest-earning assets declined to 4.49% from 5.61% in the same three months of 2008, which more than offset a decline in the average interest rate paid on interest
bearing liabilities to 3.24%, from 3.90% in the same three month period of 2008. Similarly, in the nine months ended September 30, 2009, the average rate of interest earned on average earning assets declined to 4.48%, from 5.73% in the same
nine months of 2008, and was only partially offset by a decrease in the average interest rate paid on interest bearing liabilities to 3.35%, from 4.11% in the same period of 2008. The decreases in net interest margin also reflect timing differences
in the impact that the declines in market rates of interest have on our interest income and interest expense. Those declines resulted in automatic decreases in the interest rates on our adjustable rate loans, whereas the impact of those declines on
the interest we paid on deposits was more gradual primarily as a result of the maturity schedule of our time certificates of deposit.



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##### Table of Contents

Average Balances

Information Regarding Average Assets and Average Liabilities

The following table sets forth information regarding our average balance sheet, yields on interest earning assets, interest expense on
interest-bearing liabilities, the interest rate spread and the interest rate margin for the three months ended September 30, 2009 and 2008.



|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|------------------------------------------ | ---------------------- | ------------------------------- | ------------------- | ---- | ----------------- | ------ |  | -------------- | - | ------------------- | - | ----------------- |  | - | ------ |  | ---- | -
|                                           |                        | Three Months EndedSeptember 30, |                    
|                                           | 2009                   |                                 |                     | 2008 |                  
|                                           | AverageBalance         |                                 | InterestEarned/Paid |      | AverageYield/Rate |        |  | AverageBalance |   | InterestEarned/Paid |   | AverageYield/Rate | 
|                                           | (Dollars in thousands) |                                
|                                           |                        | As Restated(1)                  |                     |      |                   |        |  |                |   |                     |   |                   |  |  
|Interest earning assets:                   |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Short-term investments(2)                  |                        | $                               | 148,568             |      | $                 | 129    |  | 0.34           | % |                     | $ | 38,526            |  | $ | 179    |  | 1.85 | %
|Securities available for sale and stock(3) |                        |                                 | 147,764             |      |                   | 814    |  | 2.19           | % |                     |   | 228,814           |  |   | 2,595  |  | 4.51 | %
|Loans                                      |                        |                                 | 842,031             |      |                   | 11,936 |  | 5.62           | % |                     |   | 813,514           |  |   | 12,456 |  | 6.09 | %
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total earning assets                       |                        |                                 | 1,138,363           |      |                   | 12,879 |  | 4.49           | % |                     |   | 1,080,854         |  |   | 15,230 |  | 5.61 | %
|Noninterest earning assets                 |                        |                                 | 48,957              |      |                   |        |  |                |   |                     |   | 35,681            |  |   |        |  |      |  
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total Assets                               |                        | $                               | 1,187,320           |      |                   |        |  |                |   |                     | $ | 1,116,535         |  |   |        |  |      |  
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Interest-bearing liabilities:              |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Interest-bearing checking accounts         |                        | $                               | 26,952              |      |                   | 58     |  | 0.85           | % |                     | $ | 20,100            |  |   | 27     |  | 0.54 | %
|Money market and savings accounts          |                        |                                 | 113,350             |      |                   | 348    |  | 1.22           | % |                     |   | 117,818           |  |   | 511    |  | 1.72 | %
|Certificates of deposit                    |                        |                                 | 604,184             |      |                   | 5,295  |  | 3.48           | % |                     |   | 450,079           |  |   | 4,969  |  | 4.39 | %
|Other borrowings                           |                        |                                 | 163,164             |      |                   | 1,648  |  | 4.01           | % |                     |   | 239,835           |  |   | 2,499  |  | 4.15 | %
|Junior subordinated debentures             |                        |                                 | 17,682              |      |                   | 146    |  | 3.28           | % |                     |   | 17,682            |  |   | 240    |  | 5.40 | %
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total interest-bearing liabilities         |                        |                                 | 925,332             |      |                   | 7,495  |  | 3.24           | % |                     |   | 845,514           |  |   | 8,246  |  | 3.90 | %
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Noninterest-bearing liabilities            |                        |                                 | 184,753             |      |                   |        |  |                |   |                     |   | 178,177           |  |   |        |  |      |  
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total Liabilities                          |                        |                                 | 1,110,085           |      |                   |        |  |                |   |                     |   | 1,023,691         |  |   |        |  |      |  
|Shareholders equity                       |                        |                                 | 77,233              |      |                   |        |  |                |   |                     |   | 92,844            |  |   |        |  |      |  
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total Liabilities and Shareholders Equity |                        | $                               | 1,187,320           |      |                   |        |  |                |   |                     | $ | 1,116,535         |  |   |        |  |      |  
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Net interest income                        |                        |                                 |                     |      | $                 | 5,384  |  |                |   |                     |   |                   |  | $ | 6,984  |  |      |  
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Interest rate spread                       |                        |                                 |                     |      |                   |        |  | 1.25           | % |                     |   |                   |  |   |        |  | 1.71 | %
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Net interest margin                        |                        |                                 |                     |      |                   |        |  | 1.88           | % |                     |   |                   |  |   |        |  | 2.56 | %
|                                           |                        |                                 |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  



|(1) | Certain of these amounts have been restated. See Note 2 to the unaudited Consolidated Financial Statements contained elsewhere in this report.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------

|(3) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------



27



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##### Table of Contents

The following table sets forth information regarding our average balance sheet, yields on
interest earning assets, interest expense on interest-bearing liabilities, the interest rate spread and the interest rate margin for the nine months ended September 30, 2009 and 2008.



|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|------------------------------------------ | ---------------------- | ------------------------------ | ------------------- | ---- | ----------------- | ------ |  | -------------- | - | ------------------- | - | ----------------- |  | - | ------ |  | ---- | -
|                                           |                        | Nine Months EndedSeptember 30, |                    
|                                           | 2009                   |                                |                     | 2008 |                  
|                                           | AverageBalance         |                                | InterestEarned/Paid |      | AverageYield/Rate |        |  | AverageBalance |   | InterestEarned/Paid |   | AverageYield/Rate | 
|                                           | (Dollars in thousands) |                               
|                                           |                        | As Restated(1)                 |                     |      |                   |        |  |                |   |                     |   |                   |  |  
|Interest earning assets:                   |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Short-term investments(2)                  |                        | $                              | 163,971             |      | $                 | 373    |  | 0.30           | % |                     | $ | 47,923            |  | $ | 803    |  | 2.24 | %
|Securities available for sale and stock(3) |                        |                                | 147,791             |      |                   | 2,912  |  | 2.63           | % |                     |   | 233,609           |  |   | 7,877  |  | 4.50 | %
|Loans                                      |                        |                                | 845,363             |      |                   | 35,529 |  | 5.62           | % |                     |   | 796,929           |  |   | 37,582 |  | 6.30 | %
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total earning assets                       |                        |                                | 1,157,125           |      |                   | 38,814 |  | 4.48           | % |                     |   | 1,078,461         |  |   | 46,262 |  | 5.73 | %
|Noninterest earning assets                 |                        |                                | 38,594              |      |                   |        |  |                |   |                     |   | 33,004            |  |   |        |  |      |  
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total Assets                               |                        | $                              | 1,195,719           |      |                   |        |  |                |   |                     | $ | 1,111,465         |  |   |        |  |      |  
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Interest-bearing liabilities:              |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Interest-bearing checking accounts         |                        | $                              | 26,036              |      |                   | 118    |  | 0.61           | % |                     | $ | 19,555            |  |   | 81     |  | 0.56 | %
|Money market and savings accounts          |                        |                                | 105,473             |      |                   | 934    |  | 1.18           | % |                     |   | 140,495           |  |   | 2,230  |  | 2.12 | %
|Certificates of deposit                    |                        |                                | 604,152             |      |                   | 16,647 |  | 3.68           | % |                     |   | 431,661           |  |   | 15,148 |  | 4.69 | %
|Other borrowings                           |                        |                                | 187,296             |      |                   | 5,425  |  | 3.87           | % |                     |   | 229,607           |  |   | 7,633  |  | 4.44 | %
|Junior subordinated debentures             |                        |                                | 17,682              |      |                   | 497    |  | 3.75           | % |                     |   | 17,682            |  |   | 787    |  | 5.95 | %
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total interest-bearing liabilities         |                        |                                | 940,639             |      |                   | 23,621 |  | 3.35           | % |                     |   | 839,000           |  |   | 25,879 |  | 4.11 | %
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Noninterest-bearing liabilities            |                        |                                | 170,509             |      |                   |        |  |                |   |                     |   | 177,177           |  |   |        |  |      |  
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total Liabilities                          |                        |                                | 1,111,148           |      |                   |        |  |                |   |                     |   | 1,016,177         |  |   |        |  |      |  
|Shareholders equity                       |                        |                                | 84,571              |      |                   |        |  |                |   |                     |   | 95,288            |  |   |        |  |      |  
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Total Liabilities and Shareholders Equity |                        | $                              | 1,195,719           |      |                   |        |  |                |   |                     | $ | 1,111,465         |  |   |        |  |      |  
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Net interest income                        |                        |                                |                     |      | $                 | 15,193 |  |                |   |                     |   |                   |  | $ | 20,383 |  |      |  
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Interest rate spread                       |                        |                                |                     |      |                   |        |  | 1.13           | % |                     |   |                   |  |   |        |  | 1.62 | %
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  
|Net interest margin                        |                        |                                |                     |      |                   |        |  | 1.76           | % |                     |   |                   |  |   |        |  | 2.52 | %
|                                           |                        |                                |                     |      |                   |        |  |                |   |                     |   |                   |  |   |        |  |      |  



|(1) | Certain of these amounts have been restated. See Note 2 to the unaudited Consolidated Financial Statements contained elsewhere in this report.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------

|(3) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------



28



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##### Table of Contents

The following table sets forth the changes in interest income, including loan fees, and
interest paid in the three and nine months ended September 30, 2009, as compared to the same respective periods of 2008, and the extent to which those changes were attributable to changes in (i) the volumes of or in the rates of interest
earned on interest-earning assets and (ii) the volumes of or the rates of interest paid on our interest-bearing liabilities.



|                                           |                        |                                                                         |       |      |                                                                        |   |        |   |  |        |        |   |      |   |        |       |  |   |        |   |  |   |        |  
|------------------------------------------ | ---------------------- | ----------------------------------------------------------------------- | ----- | ---- | ---------------------------------------------------------------------- | - | ------ | - |  | ------ | ------ | - | ---- | - | ------ | ----- |  | - | ------ | - |  | - | ------ | -
|                                           |                        | Three Months EndedSeptember 30,2009 vs. 2008Increase (decrease) due to: |       |      | Nine Months EndedSeptember 30,2009 vs. 2008Increase (decrease) due to: |  
|                                           | Volume                 |                                                                         |       | Rate |                                                                        |   | Total  |   |  | Volume |        |   | Rate |   |        | Total | 
|                                           | (Dollars in thousands) |                                                                        
|Interest income:                           |                        |                                                                         |       |      |                                                                        |   |        |   |  |        |        |   |      |   |        |       |  |   |        |   |  |   |        |  
|Short-term investments(1)                  |                        | $                                                                       | 189   |      |                                                                        | $ | (239   | ) |  | $      | (50    | ) |      | $ | 705    |       |  | $ | (1,135 | ) |  | $ | (430   | )
|Securities available for sale and stock(2) |                        |                                                                         | (725  | )    |                                                                        |   | (1,056 | ) |  |        | (1,781 | ) |      |   | (2,331 | )     |  |   | (2,634 | ) |  |   | (4,965 | )
|Loans                                      |                        |                                                                         | 437   |      |                                                                        |   | (957   | ) |  |        | (520   | ) |      |   | 2,181  |       |  |   | (4,234 | ) |  |   | (2,053 | )
|                                           |                        |                                                                         |       |      |                                                                        |   |        |   |  |        |        |   |      |   |        |       |  |   |        |   |  |   |        |  
|Total earning assets                       |                        |                                                                         | (99   | )    |                                                                        |   | (2,252 | ) |  |        | (2,351 | ) |      |   | 555    |       |  |   | (8,003 | ) |  |   | (7,448 | )
|Interest expense:                          |                        |                                                                         |       |      |                                                                        |   |        |   |  |        |        |   |      |   |        |       |  |   |        |   |  |   |        |  
|Interest-bearing checking accounts         |                        |                                                                         | 12    |      |                                                                        |   | 19     |   |  |        | 31     |   |      |   | 29     |       |  |   | 8      |   |  |   | 37     |  
|Money market and savings accounts          |                        |                                                                         | (19   | )    |                                                                        |   | (144   | ) |  |        | (163   | ) |      |   | (468   | )     |  |   | (828   | ) |  |   | (1,296 | )
|Certificates of deposit                    |                        |                                                                         | 1,494 |      |                                                                        |   | (1,169 | ) |  |        | 325    |   |      |   | 5,195  |       |  |   | (3,696 | ) |  |   | 1,499  |  
|Borrowings                                 |                        |                                                                         | (771  | )    |                                                                        |   | (80    | ) |  |        | (851   | ) |      |   | (1,303 | )     |  |   | (905   | ) |  |   | (2,208 | )
|Junior subordinated debentures             |                        |                                                                         |      |      |                                                                        |   | (93    | ) |  |        | (93    | ) |      |   |       |       |  |   | (290   | ) |  |   | (290   | )
|                                           |                        |                                                                         |       |      |                                                                        |   |        |   |  |        |        |   |      |   |        |       |  |   |        |   |  |   |        |  
|Total interest-bearing liabilities         |                        |                                                                         | 716   |      |                                                                        |   | (1,467 | ) |  |        | (751   | ) |      |   | 3,453  |       |  |   | (5,711 | ) |  |   | (2,258 | )
|                                           |                        |                                                                         |       |      |                                                                        |   |        |   |  |        |        |   |      |   |        |       |  |   |        |   |  |   |        |  
|Net interest income                        |                        | $                                                                       | (815  | )    |                                                                        | $ | (785   | ) |  | $      | (1,600 | ) |      | $ | (2,898 | )     |  | $ | (2,292 | ) |  | $ | (5,190 | )
|                                           |                        |                                                                         |       |      |                                                                        |   |        |   |  |        |        |   |      |   |        |       |  |   |        |   |  |   |        |  



|(1) | Short-term investments consist of federal funds sold and interest bearing deposits with financial institutions.
|--- | ---------------------------------------------------------------------------------------------------------------

|(2) | Stock consists of Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
|--- | ------------------------------------------------------------------------------

The above table indicates that the decreases in our net interest income of $1.6 million and $5.2 million in the three and nine
months ended September 30, 2009, respectively, were primarily attributable to decreases in rate variances of $785,000 and $2.3 million, respectively, and in volume variances of $815,000 million and $2.9 million, respectively, in
the three and nine months ended September 30, 2009. Those decreases in volume variance were primarily the result of (i) decreases in the volume of securities available for sale and increases in the volume of loans, and (ii) changes in
the mix of our deposits to a greater proportion of higher-cost certificates of deposit, as compared to lower-cost transaction savings and money market deposits. The declines in rate variances were a result of decreases in interest rates on average
earning assets of 112 basis points and 125 basis points, respectively, which was only partially offset by decreases in interest rates paid on interest bearing liabilities of 66 basis points and 76 basis points, respectively, in
the three and nine months ended September 30, 2009.

Provision for Loan Losses

The failure of borrowers to repay their loans is an inherent risk of the banking business. Therefore, like virtually all banks and other
lending institutions, we follow the practice of maintaining reserves (referred to as an allowance) to provide for loan losses that occur from time to time as an incidental part of the banking business. When it is determined that the
payment in full of a loan has become unlikely, the carrying value of the loan is reduced to what management believes is its realizable value. This reduction, which is referred to as a loan charge-off, or write-down is charged
against that allowance.

The amount of the allowance for loan losses is increased periodically (i) to replenish the
allowance after it has been reduced due to loan charge-offs, (ii) to reflect changes in the volume of outstanding loans, and (iii) to take account of increases in the risk of potential future losses due to a deterioration in the condition
of borrowers or in the value of property securing nonperforming loans or adverse changes in economic conditions. Increases in the allowance for loan losses are made through a charge, recorded as an expense in the statement of operations,
referred to as the provision for loan losses. Recoveries of loans previously charged-off are added back to the allowance and, therefore, have the effect of increasing the allowance and reducing the amount of the provision that might
otherwise have had to be made to replenish or increase the allowance. See Financial ConditionNonperforming Loans andAllowance for Loan Losses below in this Section of this Report.



29



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##### Table of Contents

During the three and nine months ended September 30, 2009, we made provisions of
$3.8 million and $13.8 million, respectively, for potential loan losses, as compared to $1.6 million and $5.4 million, respectively, in the respective corresponding periods of 2008. Those increases were made (i) to replenish
the allowance for loan losses following net loan charge-offs of $3.8 million and $8.9 million, respectively, during those three and nine month periods of 2009, and (ii) to increase the allowance for loan losses to provide for the
increase that occurred in non-accrual loans during the first nine months of 2009, and increases that we believe may occur in the foreseeable future. Nonaccrual loans increased to $59.6 million at September 30, 2009, as compared to
$6.3 million at September 30, 2008, as a result of the continuing economic recession and credit crisis.

We employ
economic models that are based on bank regulatory guidelines, industry standards and loss ratios and our own historical loss experience to evaluate and make judgments regarding the sufficiency of the allowance for loan losses and the amount of the
provisions that are required to be made for potential loan losses. Those judgments are based on, among other things, our assessments and assumptions about trends in current economic conditions and other events that can affect the ability of
borrowers to meet their loan obligations to us. The duration and effects of current economic trends or conditions, such as the current economic recession, are subject to a number of risks and uncertainties and changes that are outside of our ability
to control. See Financial ConditionNonperforming Loans and Allowance for Loan Losses below. If economic or market conditions were to worsen or unexpected subsequent events were to occur, causing our earlier assumptions
regarding such matters to have been incorrect, it could become necessary for us to make additional provisions to increase the allowance for loan losses, which would have the effect of reducing our income.

In addition, the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions, as an integral part of their
examination processes, periodically review the adequacy of our allowance for loan losses. These bank regulatory agencies may require us to make additional provisions, over and above the provisions that we have already made, the effect of which would
be to further reduce our income.

Noninterest Income

Noninterest income consists primarily of fees charged for services provided by the Bank on deposit account transactions and gains on sales of
assets and, during the current fiscal year, income from the origination and sale of residential mortgages. The following table identifies the amounts (in thousands of dollars) of, and sets forth the percentage changes in, the components of
noninterest income in the three and nine months ended September 30, 2009, as compared to the same respective periods of 2008.



|                                                                              |        |                                 |                               |      |                                |        |      |  |                               |      |  |   |       |   |  |   |       |   |  |        |   
|----------------------------------------------------------------------------- | ------ | ------------------------------- | ----------------------------- | ---- | ------------------------------ | ------ | ---- |  | ----------------------------- | ---- |  | - | ----- | - |  | - | ----- | - |  | ------ | --
|                                                                              |        | Three Months EndedSeptember 30, |                               |      | Nine Months EndedSeptember 30, |       
|                                                                              | Amount |                                 | PercentageChange2009 vs. 2008 |      |                                | Amount |      |  | PercentageChange2009 vs. 2008 |     
|                                                                              | 2009   |                                 |                               | 2008 |                                |        | 2009 |  |                               | 2008 |  |  
|Service fees on deposits                                                      |        | $                               | 352                           |      |                                | $      | 326  |  | 8.0                           | %    |  | $ | 1,101 |   |  | $ | 823   |   |  | 33.8   | % 
|Mortgage banking income (including net gains on sales of loans held for sale) |        |                                 | 540                           |      |                                |        |     |  | N/M                           |      |  |   | 607   |   |  |   |      |   |  | N/M    |   
|Net gains on sales of securities available for sale                           |        |                                 | 446                           |      |                                |        | 127  |  | 251.2                         | %    |  |   | 2,334 |   |  |   | 1,259 |   |  | 85.4   | % 
|Net gain (loss) on sale of other real estate owned                            |        |                                 | (147                          | )    |                                |        |     |  | N/M                           |      |  |   | (145  | ) |  |   | (40   | ) |  | (262.5 | )%
|Other                                                                         |        |                                 | 284                           |      |                                |        | 251  |  | 13.1                          | %    |  |   | 693   |   |  |   | 547   |   |  | 26.7   | % 
|                                                                              |        |                                 |                               |      |                                |        |      |  |                               |      |  |   |       |   |  |   |       |   |  |        |   
|Total Noninterest Income                                                      |        | $                               | 1,475                         |      |                                | $      | 704  |  | 109.5                         | %    |  | $ | 4,590 |   |  | $ | 2,589 |   |  | 77.3   | % 
|                                                                              |        |                                 |                               |      |                                |        |      |  |                               |      |  |   |       |   |  |   |       |   |  |        |   

As the table above indicates, the increase in noninterest income in the three months ended
September 30, 2009, as compared to the same period in 2008, were primarily attributable to (i) $540,000 of income generated by our new mortgage banking division which commenced its operations during the second quarter 2009, and (ii) a
$319,000 or 251% increase in net gains on sales of securities available for sale partially offset by a $147,000 loss on sale of other real estate owned. The increase in noninterest income in the nine months ended September 30, 2009, as compared
to the same period in 2008, was primarily the result of a $278,000 increase in service charges on deposit account transactions, $607,000 of income generated by our new mortgage banking division, and $1.1 million increase in gains on sales of
securities available for sale the proceeds from which were used to repay borrowings and, to a lesser extent, fund new loans.



30



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##### Table of Contents

Noninterest Expense

The following table compares the amounts (in thousands of dollars) of the principal components of noninterest expense in the three and nine
month periods ended September 30, 2009 and September 30, 2008.



|                               |                        |                                 |                               |  |                                |        |  |                               |    |  |   |        |  |   |        |  |       |   
|------------------------------ | ---------------------- | ------------------------------- | ----------------------------- |  | ------------------------------ | ------ |  | ----------------------------- | -- |  | - | ------ |  | - | ------ |  | ----- | --
|                               |                        | Three Months EndedSeptember 30, |                               |  | Nine Months EndedSeptember 30, |       
|                               | Amount                 |                                 | PercentageChange2009 vs. 2008 |  |                                | Amount |  | PercentageChange2009 vs. 2008 |   
|                               | 2009                   |                                 | 2008                          |  |                                | 2009   |  | 2008                          |   
|                               | (Dollars in thousands) |                                
|Salaries and employee benefits |                        | $                               | 4,194                         |  | $                              | 3,226  |  | 30.0                          | %  |  | $ | 11,580 |  | $ | 9,348  |  | 23.9  | % 
|Occupancy                      |                        |                                 | 682                           |  |                                | 685    |  | (0.4                          | )% |  |   | 2,038  |  |   | 2,064  |  | (1.3  | )%
|Equipment and depreciation     |                        |                                 | 313                           |  |                                | 252    |  | 24.2                          | %  |  |   | 868    |  |   | 818    |  | 6.1   | % 
|Data processing                |                        |                                 | 276                           |  |                                | 161    |  | 71.4                          | %  |  |   | 662    |  |   | 511    |  | 29.5  | % 
|Professional fees              |                        |                                 | 1,338                         |  |                                | 249    |  | 437.3                         | %  |  |   | 2,740  |  |   | 831    |  | 229.7 | % 
|Customer expense               |                        |                                 | 92                            |  |                                | 121    |  | (24.0                         | )% |  |   | 281    |  |   | 369    |  | (23.8 | )%
|FDIC insurance                 |                        |                                 | 683                           |  |                                | 166    |  | 311.4                         | %  |  |   | 1,933  |  |   | 478    |  | 304.4 | % 
|Other real estate owned        |                        |                                 | 1,170                         |  |                                | 65     |  | N/M                           |    |  |   | 1,689  |  |   | 494    |  | 241.9 | % 
|Other operating expense(1)     |                        |                                 | 764                           |  |                                | 641    |  | 19.2                          | %  |  |   | 2,252  |  |   | 2,042  |  | 10.3  | % 
|                               |                        |                                 |                               |  |                                |        |  |                               |    |  |   |        |  |   |        |  |       |   
|Total                          |                        | $                               | 9,512                         |  | $                              | 5,566  |  | 70.9                          | %  |  | $ | 24,043 |  | $ | 16,955 |  | 41.8  | % 
|                               |                        |                                 |                               |  |                                |        |  |                               |    |  |   |        |  |   |        |  |       |   



|(1) | Other operating expenses primarily consist of telephone, stationery and office supplies, regulatory expenses, investor relations expenses, insurance premiums, postage
and correspondent banking fees.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For the three and nine months ended September 30, 2009, noninterest
expenses increased by $3.9 million, or 71%, and by $7.1 million, or 42%, respectively, compared to the three and nine months ended September 30, 2008. Those increases were due primarily to increases in the three and nine months ended
September 30, 2009 of (i) $968,000, or 30%, and $2.2 million, or 24%, respectively, in employee compensation expense due primarily to the addition of personnel in our credit administration department and personnel for our new mortgage
banking business which commenced operations during the second quarter 2009, (ii) $1.1 million, or 437%, and $1.9 million, or 230%, respectively, in professional fees incurred in connection with the collection and foreclosures of non-performing
loans and in the carrying costs of the properties acquired by foreclosure (OREO properties), (iii) $517,000, or 311%, and $1.5 million, or 304%, respectively, in FDIC insurance premiums imposed on all FDIC-insured banks to offset
losses to the FDICs insurance fund as a result of the significant increase in bank failures that have occurred in the past 12 months, and (iv) $1.1 million, and $1.2 million respectively, of additional write downs in the carrying
values of OREO properties based upon recent third party appraisals of those properties.

Due to the combined effects of the
declines in net interest income and the increases in non-interest expense, our efficiency ratios (the ratio of non-interest expense to the sum of net interest income and noninterest income) were 139% and 122% in the three and nine months ended
September 30, 2009, respectively, as compared to 72% and 74% for the corresponding three and nine month periods of 2008.

Income Tax Provision (Benefit)

We recorded income tax benefits of $2.6 million and $7.5 million for
the three and nine months ended September 30, 2009, respectively, as compared to income tax expense of $143,000 and $51,000, respectively, in the respective corresponding periods of 2008. The income tax benefits were due primarily to the
pre-tax losses incurred in the three and nine months ended September 30, 2009.

Asset/Liability Management

The primary objective of asset/liability management is to reduce our exposure to interest rate fluctuations, which can affect
our net interest margins and, therefore, our net interest income and net earnings. We seek to achieve this objective by matching interest rate sensitive assets and liabilities, and maintaining the maturities of and repricing these assets and
liabilities in response to the changes in the interest rate environment. Generally, if rate sensitive assets exceed rate sensitive liabilities, net interest income will be positively impacted during a rising interest rate environment and negatively
impacted during a declining interest rate environment. When rate sensitive liabilities exceed rate sensitive assets, net interest income generally will be positively impacted during a declining interest rate environment and



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negatively impacted during a rising interest rate environment. However, interest rates for different asset and liability products offered by depository institutions respond differently to changes
in the interest rate environment. As a result, the relationship or gap between interest sensitive assets and interest sensitive liabilities is only a general indicator of interest rate sensitivity and how our net interest income might be
affected by changing rates of interest.

For example, rates on certain assets or liabilities typically lag behind changes in
market rates of interest. Additionally, prepayments of loans and securities available for sale, and early withdrawals of certificates of deposit, can cause the interest sensitivities to vary.

The table below sets forth information concerning our rate sensitive assets and liabilities at September 30, 2009. The assets and
liabilities are classified by the earlier of maturity or repricing dates in accordance with their contractual terms. As described above, certain shortcomings are inherent in the method of analysis presented in this table.



|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|---------------------------------------------------------------------------- | ---------------------- | ----------------- | ------- | - | ----------------------------- | - | -------- | ----------------------------- |  | - | ------------- | - |  | -------------------- | ------- | - | ----- | - | -------- | - |  | - | ---------
|                                                                             |                        | ThreeMonthsorLess |         |   | Over ThreeThroughTwelveMonths |   |          | Over OneYearThroughFive Years |  |   | OverFiveYears |   |  | Non-Interest-Bearing |         |   | Total
|                                                                             | (Dollars in thousands)
|Assets                                                                       |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Interest-bearing deposits in other financial institutions                    |                        | $                 | 7,099   |   |                               | $ | 9,701    |                               |  | $ |              |   |  | $                    |        |   |       | $ |         |   |  | $ | 16,800   
|Investment in unconsolidated trust subsidiaries                              |                        |                   |        |   |                               |   |         |                               |  |   |              |   |  |                      | 682     |   |       |   |         |   |  |   | 682      
|Securities available for sale                                                |                        |                   | 63,080  |   |                               |   | 22,570   |                               |  |   | 17,072        |   |  |                      | 13,761  |   |       |   |         |   |  |   | 116,483  
|Federal Reserve Bank and Federal Home Loan Bank stock                        |                        |                   | 13,603  |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 13,603   
|Interest bearing deposits with financial institutions                        |                        |                   | 79,995  |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 79,995   
|Loans held for sale, at fair value                                           |                        |                   | 10,598  |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 10,598   
|Loans, gross                                                                 |                        |                   | 369,054 |   |                               |   | 72,610   |                               |  |   | 323,393       |   |  |                      | 69,825  |   |       |   |         |   |  |   | 834,882  
|Non-interest earning assets, net(1)                                          |                        |                   |        |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 35,536   |   |  |   | 35,536   
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Total assets(1)                                                              |                        | $                 | 543,429 |   |                               | $ | 104,881  |                               |  | $ | 340,465       |   |  | $                    | 84,268  |   |       | $ | 35,536   |   |  | $ | 1,108,579
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Liabilities and Shareholders Equity                                          |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Noninterest-bearing deposits                                                 |                        | $                 |        |   |                               | $ |         |                               |  | $ |              |   |  | $                    |        |   |       | $ | 179,270  |   |  | $ | 179,270  
|Interest-bearing deposits(2) (3)                                             |                        |                   | 295,474 |   |                               |   | 313,127  |                               |  |   | 69,667        |   |  |                      |        |   |       |   |         |   |  |   | 678,268  
|Borrowings                                                                   |                        |                   | 31,000  |   |                               |   | 114,000  |                               |  |   | 7,000         |   |  |                      |        |   |       |   |         |   |  |   | 152,000  
|Junior subordinated debentures                                               |                        |                   | 17,527  |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   |         |   |  |   | 17,527   
|Other liabilities                                                            |                        |                   |        |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 7,090    |   |  |   | 7,090    
|Shareholders equity                                                         |                        |                   |        |   |                               |   |         |                               |  |   |              |   |  |                      |        |   |       |   | 74,424   |   |  |   | 74,424   
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Total liabilities and shareholders equity                                    |                        | $                 | 344,001 |   |                               | $ | 427,127  |                               |  | $ | 76,667        |   |  | $                    |        |   |       | $ | 260,784  |   |  | $ | 1,108,579
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Interest rate sensitivity gap                                                |                        | $                 | 199,428 |   |                               | $ | (322,246 | )                             |  | $ | 263,798       |   |  | $                    | 84,268  |   |       | $ | (225,248 | ) |  | $ |         
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Cumulative interest rate sensitivity gap                                     |                        | $                 | 199,428 |   |                               | $ | (122,818 | )                             |  | $ | 140,980       |   |  | $                    | 225,248 |   |       | $ |         |   |  | $ |         
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Cumulative % of rate sensitive assets in maturity period                     |                        |                   | 49      | % |                               |   | 58       | %                             |  |   | 89            | % |  |                      | 97      | % |       |   | 100      | % |  |   |          
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Rate sensitive assets to rate sensitive liabilities and shareholders equity |                        |                   | 158     | % |                               |   | 25       | %                             |  |   | 444           | % |  |                      | N/A     |   |       |   | 14       | % |  |   |          
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          
|Cumulative ratio                                                             |                        |                   | 158     | % |                               |   | 84       | %                             |  |   | 117           | % |  |                      | 127     | % |       |   | 100      | % |  |   |          
|                                                                             |                        |                   |         |   |                               |   |          |                               |  |   |               |   |  |                      |         |   |       |   |          |   |  |   |          



|(1) | Certain of these amounts have been restated. See Note 2 to the unaudited Consolidated Financial Statements contained elsewhere in this report.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Excludes savings accounts we maintain at the Bank totaling $3.9 million and maturing within three months of September 30, 2009.
|--- | -------------------------------------------------------------------------------------------------------------------------------

|(3) | Excludes a $250,000 certificate of deposit issued to us by the Bank, which matures within 12 months of September 30, 2009.
|--- | --------------------------------------------------------------------------------------------------------------------------



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At September 30, 2009, our rate sensitive balance sheet was shown to be in a negative
twelve-month gap position. This would imply that our net interest margin would decrease in the shortterm if interest rates were to rise and would increase in the short-term if interest rates were to fall. However, as noted above, the extent to
which our net interest margin will be impacted by changes in prevailing interests rates will depend on a number of factors, including how quickly rate sensitive assets and liabilities react to interest rate changes, the mix of our interest earning
assets (loans versus other lower yielding interest earning assets, such as securities or federal funds sold) and the mix of our interest bearing deposits (between, for example, lower interest core deposits and higher cost time certificates of
deposit) and our other interest-bearing liabilities.

Financial Condition

Assets

Our
total consolidated assets decreased by $53 million to $1.111 billion at September 30, 2009 from $1.164 billion at December 31, 2008, as we recognized gains by selling our securities available for sale during the nine months ended
September 30, 2009. The following table sets forth the composition of our interest-earning assets (in thousands of dollars) at:



|                                                                  |  |                   |         |                  |   |        
|----------------------------------------------------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                                                                  |  | September 30,2009 |         | December 31,2008
|Interest-bearing deposits with financial institutions(1)          |  | $                 | 79,995  |                  | $ | 90,707 
|Interest-bearing time deposits with financial institutions        |  |                   | 16,800  |                  |   | 198    
|Federal Reserve Bank and Federal Home Loan Bank Stock, at cost    |  |                   | 13,603  |                  |   | 13,420 
|Securities available for sale, at fair value                      |  |                   | 116,483 |                  |   | 160,945
|Loans held for sale, at lower of cost or market                   |  |                   | 10,598  |                  |   |       
|Loans (net of allowances of $20,500 and $15,453, respectively)(2) |  |                   | 814,332 |                  |   | 828,041



|(1) | Includes interest-earning balances maintained at the Federal Reserve Bank of San Francisco.
|--- | -------------------------------------------------------------------------------------------

|(2) | The amount of the loans and allowance for loan losses at September 30, 2009 have been restated. See Note 2 to the unaudited Consolidated Financial Statements included
elsewhere in this report.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Loans Held for Sale

We commenced a new mortgage banking business during the second quarter of 2009 to originate residential real estate mortgage loans that
qualify for resale into the secondary mortgage markets. Through September 30, 2009, we had originated approximately $40.7 million of conventional and FHA/VA single-family mortgages and had sold approximately $28.9 million of those loans in the
secondary mortgage market. The loans classified as loans held for sale are carried at the lower of cost or market. The remainder of the loans held for sale at September 30, 2009 totaled $10.6 million. Pursuant to ASC 815-10, in the three month
period ended September 30, 2009 we recorded a positive mark-to-market valuation of $166,000 to noninterest income for the loans held for sale. During that period we did not establish any fair value hedges for these loans.



33



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Loans

The following table sets forth, in thousands of dollars, the composition, by loan category, of our loan portfolio at September 30, 2009 and December 31, 2008, respectively:



|                                              |                |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|--------------------------------------------- | -------------- | ------------------ | ------- | ------- | ----------------- | ----- | ------ |  | - | ------- | - |  | ----- | -
|                                              |                | September 30, 2009 |         |         | December 31, 2008 |      
|                                              | Amount         |                    |         | Percent |                   |       | Amount |  |   | Percent |  
|                                              | As Restated(1) |                    |         |         |                   |       |        |  |   |         |  
|Commercial loans                              |                | $                  | 292,757 |         |                   | 35.1  | %      |  | $ | 300,945 |   |  | 35.7  | %
|Commercial real estate loans - owner occupied |                |                    | 181,135 |         |                   | 21.7  | %      |  |   | 174,169 |   |  | 20.6  | %
|Commercial real estate loans - all other      |                |                    | 131,351 |         |                   | 15.7  | %      |  |   | 127,528 |   |  | 15.1  | %
|Residential mortgage loans - multi- family    |                |                    | 103,690 |         |                   | 12.4  | %      |  |   | 100,971 |   |  | 12.0  | %
|Residential mortgage loans - single-family    |                |                    | 63,616  |         |                   | 7.6   | %      |  |   | 65,127  |   |  | 7.7   | %
|Construction loans                            |                |                    | 22,880  |         |                   | 2.7   | %      |  |   | 32,528  |   |  | 3.9   | %
|Land development loans                        |                |                    | 31,607  |         |                   | 3.8   | %      |  |   | 33,283  |   |  | 3.9   | %
|Consumer loans                                |                |                    | 8,164   |         |                   | 1.0   | %      |  |   | 9,173   |   |  | 1.1   | %
|                                              |                |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|Gross loans(2)                                |                |                    | 835,200 |         |                   | 100.0 | %      |  |   | 843,724 |   |  | 100.0 | %
|                                              |                |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|Deferred fee (income) costs, net              |                |                    | (368    | )       |                   |       |        |  |   | (230    | ) |  |       |  
|Allowance for loan losses                     |                |                    | (20,500 | )       |                   |       |        |  |   | (15,453 | ) |  |       |  
|                                              |                |                    |         |         |                   |       |        |  |   |         |   |  |       |  
|Loans, net                                    |                | $                  | 814,332 |         |                   |       |        |  | $ | 828,041 |   |  |       |  
|                                              |                |                    |         |         |                   |       |        |  |   |         |   |  |       |  



|(1) | See Note 2 to the unaudited Consolidated Financial Statements included elsewhere in this report.
|--- | ------------------------------------------------------------------------------------------------

|(2) | Although, as indicated by this table, the volume of loans outstanding at September 30, 2009 was lower than at December 31, 2008, the average volume of loans
outstanding during the nine months ended September 30, 2009 totaled $848 million, as compared to (i) $796 million for the same nine months of 2008 and $745 million for the year ended December 31, 2008.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Commercial loans are loans to businesses to finance capital purchases or improvements, or to provide cash flow
for operations. Commercial real estate and residential mortgage loans are loans secured by trust deeds on real property, including commercial property and single family and multi-family residences. Construction and land development loans are interim
loans to finance specific construction projects. Consumer loans consist primarily of installment loans to consumers.

The
following table sets forth, in thousands of dollars, the maturity distribution of our loan portfolio (excluding consumer and residential mortgage loans) at September 30, 2009:



|                                      |                 |                    |                               |  |                |         |       |   |        |  |   |        
|------------------------------------- | --------------- | ------------------ | ----------------------------- |  | -------------- | ------- | ----- | - | ------ |  | - | -------
|                                      |                 | September 30, 2009
|                                      | One Yearor Less |                    | Over OneYearthroughFive Years |  | Over FiveYears |         | Total
|Real estate and construction loans(1) |                 |                    |                               |  |                |         |       |   |        |  |   |        
|Floating rate                         |                 | $                  | 50,822                        |  | $              | 120,296 |       | $ | 9,625  |  | $ | 180,743
|Fixed rate                            |                 |                    | 58,884                        |  |                | 88,725  |       |   | 38,621 |  |   | 186,230
|Commercial loans                      |                 |                    |                               |  |                |         |       |   |        |  |   |        
|Floating rate                         |                 |                    | 57,526                        |  |                | 2,457   |       |   |       |  |   | 59,983 
|Fixed rate                            |                 |                    | 147,057                       |  |                | 59,128  |       |   | 26,589 |  |   | 232,774
|                                      |                 |                    |                               |  |                |         |       |   |        |  |   |        
|Total                                 |                 | $                  | 314,289                       |  | $              | 270,606 |       | $ | 74,835 |  | $ | 659,730
|                                      |                 |                    |                               |  |                |         |       |   |        |  |   |        



|(1) | Does not include mortgage loans on single and multi-family residences and consumer loans, which totaled $167.3 million and $8.2 million, respectively, at
September 30, 2009.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Nonperforming Loans and Allowance for Loan Losses

Nonperforming Loans. Non-performing loans consist of loans on non-accrual status, which include restructured loans for which there has
not been a history of past performance on debt service in accordance with their contractual terms as restructured. Non-performing assets consist of non-performing loans and OREO, which consists of real properties which have been acquired by
foreclosure or similar means and which management intends to offer for sale. Loans are placed on non-accrual status



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when, in the opinion of management, the full timely collection of principal or interest is in doubt. Generally, the accrual of interest is discontinued when principal or interest payments become
more than 90 days past due, unless management believes the loan is adequately collateralized and in the process of collection. However, in certain instances, we may place a particular loan on non-accrual status earlier, depending upon the individual
circumstances involved in loans delinquency. When a loan is placed on non-accrual status, previously accrued but unpaid interest is reversed against current income. Subsequent collections of cash are applied as principal reductions when
received, except when the ultimate collectibility of principal is probable, in which case interest payments are credited to income. Non-accrual loans may be restored to accrual status when principal and interest become current and full repayment is
expected. Interest income is recognized on the accrual basis for impaired loans not meeting the criteria for non-accrual.

The
following table sets forth information regarding nonaccrual loans and other real estate owned which, together, comprise our nonperforming assets, and restructured loans, at September 30, 2009 and December 31, 2008:



|                                                       |  |                       |        |                      |   |       
|------------------------------------------------------ |  | --------------------- | ------ | -------------------- | - | ------
|                                                       |  | At September 30, 2009 |        | At December 31, 2008
|Nonaccrual loans:                                      |  |                       |        |                      |   |       
|Commercial loans                                       |  | $                     | 23,280 |                      | $ | 5,865 
|Commercial real estate                                 |  |                       | 20,689 |                      |   |      
|Residential real estate                                |  |                       | 599    |                      |   | 2,478 
|Construction and land development                      |  |                       | 15,008 |                      |   | 7,555 
|Consumer loans                                         |  |                       |       |                      |   | 27    
|                                                       |  |                       |        |                      |   |       
|Total nonaccrual loans                                 |  | $                     | 59,576 |                      | $ | 15,925
|                                                       |  |                       |        |                      |   |       
|Other real estate owned (OREO):                        |  |                       |        |                      |   |       
|Construction and land development                      |  |                       | 4,465  |                      |   | 5,430 
|Residential-multi family                               |  |                       |       |                      |   | 976   
|Residential-single family                              |  |                       | 5,297  |                      |   | 2,408 
|Commercial real estate                                 |  |                       | 4,230  |                      |   | 5,194 
|                                                       |  |                       |        |                      |   |       
|Total other real estate owned                          |  |                       | 13,992 |                      |   | 14,008
|                                                       |  |                       |        |                      |   |       
|Total nonperforming assets                             |  | $                     | 73,568 |                      | $ | 29,933
|                                                       |  |                       |        |                      |   |       
|Restructured loans:                                    |  |                       |        |                      |   |       
|Accruing loans                                         |  |                       | 2,422  |                      |   | 2,606 
|Nonaccruing loans (included in nonaccrual loans above) |  |                       | 19,831 |                      |   | 4,913 
|                                                       |  |                       |        |                      |   |       
|Total Restructured Loans                               |  | $                     | 22,253 |                      | $ | 7,519 
|                                                       |  |                       |        |                      |   |       

The increase in non-performing loans was attributable
primarily to the continuing economic recession which adversely affected the ability of some borrowers to meet their loan payment obligations and the tightening of available credit that has prevented such borrowers from refinancing their loans with
us. However, of the $59.6 million of non-accrual loans at September 30, 2009, approximately $41.5 million, or 70%, were secured either directly or indirectly by real estate collateral which is expected to mitigate losses we might otherwise
incur on those loans. We also have either charged off or set aside reserves specifically for these loans, based on recent appraisals of those properties. In addition, the remaining $18.1 million in nonaccrual loans are secured by other non-real
estate collateral. There can be no assurance, however, that we will not incur losses in a greater amount on these loans, particularly if real property values continue to decline or the credit crisis makes it difficult to find buyers for these
properties.

Loans that have been restructured remain in a non-accrual status unless and until there has been six months of
satisfactory performance by the borrowers in accordance with the restructured terms of those loans, at which time the loans usually are returned to accrual status. At September 30, 2009, we had entered into loan restructuring agreements with
respect to $19.8 million of loans carried on a non-accrual basis. If and to the extent that such loans perform as restructured for that six month period, they will be returned to accrual status.

On October 15, 2009, we completed the sale of an OREO property with a carrying value of $1.5 million. No material additional
losses were recognized on that sale. On the other hand, as of September 30, 2009, we were in the process of foreclosing two other properties, collateralizing non-performing loans with an estimated current market value totaling approximately
$2.1 million. As a result, we may incur losses on those properties before we can complete their sale.



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Information Regarding Impaired Loans. A loan is deemed impaired when, based on
current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. At September 30, 2009, there were $62.0 million of loans deemed impaired as compared to
$18.5 million at December 31, 2008. We had an average investment in impaired loans for the nine months ended September 30, 2009 of $49.8 million as compared to $17.8 million for the year ended December 31, 2008. The
interest that would have been earned during the nine month period ended September 30, 2009 had the impaired loans remained current in accordance with their original terms was $1.7 million.

The following table sets forth the amount of impaired loans for which there is a related allowance for credit losses determined in
accordance with ASC 310-10 and the amount of that allowance and the amount of impaired loans for which there is no allowance for credit losses, at September 30, 2009 and December 31, 2008:



|                                |                        |                   |                         |  |                      |       |  |       |   |                         |   |                      |  |   |       |  |      |  
|------------------------------- | ---------------------- | ----------------- | ----------------------- |  | -------------------- | ----- |  | ----- | - | ----------------------- | - | -------------------- |  | - | ----- |  | ---- | -
|Impaired Loans                  |                        | September 30,2009 |                         |  | December 31, 2008    |      
|                                | (Dollars in thousands) |                  
|                                | Loans                  |                   | Reserves forLoan Losses |  | % ofReserves toLoans |       |  | Loans |   | Reserves forLoan Losses |   | % ofReserves toLoans | 
|Impaired loans with reserves    |                        | $                 | 22,771                  |  | $                    | 6,932 |  | 30.4  | % |                         | $ | 14,869               |  | $ | 2,084 |  | 14.0 | %
|Impaired loans without reserves |                        |                   | 38,958                  |  |                      |      |  |      |   |                         |   | 3,662                |  |   |      |  |     |  
|                                |                        |                   |                         |  |                      |       |  |       |   |                         |   |                      |  |   |       |  |      |  
|Total impaired loans            |                        | $                 | 61,729                  |  | $                    | 6,932 |  | 11.2  | % |                         | $ | 18,531               |  | $ | 2,084 |  | 11.3 | %
|                                |                        |                   |                         |  |                      |       |  |       |   |                         |   |                      |  |   |       |  |      |  

Allowance for Loan Losses. The allowance for loan losses (the Allowance) at
September 30, 2009 was $20.5 million, which represented approximately 2.46% of the loans outstanding at September 30, 2009, as compared to $15.5 million, or 1.83%, of the loans outstanding at December 31, 2008.

The adequacy of the Allowance is determined through periodic evaluations of the loan portfolio and other factors that can reasonably be
expected to affect the ability of borrowers to meet their loan obligations. Those factors are inherently subjective as the process calls for various significant estimates and assumptions. Among other factors, the estimates involve the amounts and
timing of expected future cash flows and fair value of collateral on impaired loans, estimated losses on loans based on historical loss experience and industry loss factors, various qualitative factors, and uncertainties in estimating losses and
inherent risks in the various loan portfolios, which may be subject to substantial change.

The Allowance is first determined
by assigning reserve ratios for all loans. All non-accrual loans and other loans classified as special mention, substandard or doubtful (classified loans or classification categories) are
then assigned certain allocations according to type of loans, with greater reserve ratios or percentages applied to loans deemed to be of a higher risk. These ratios are determined based on prior loss history and industry guidelines and loss
factors, by type of loan, adjusted for current economic factors.

On a quarterly basis, we utilize a classification migration
model and individual loan review analysis tools as starting points for determining the adequacy of the Allowance. Our loss migration analysis tracks a certain number of quarters of loan loss history and industry loss factors to determine historical
losses by classification category for each loan type, except certain loans (automobile, mortgage and credit cards), which are analyzed as homogeneous loan pools. These calculated loss factors are then applied to outstanding loan balances. We also
conduct individual loan review analysis, as part of the Allowance allocation process, applying specific monitoring policies and procedures in analyzing the existing loan portfolios.

In determining whether and the extent to which we will make adjustments to our loan loss migration model for purposes of determining the
Allowance, we also consider a number of qualitative factors that can affect the performance and the collectibility of the loans in our loan portfolio. Such qualitative factors include:



| |  |  | The effects of changes that we may make in our loan policies or underwriting standards on the quality of the loans and the risks in our loan
portfolios;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Trends and changes in local, regional and national economic conditions, as well as changes in industry specific conditions, and any other reasonably
foreseeable events that could affect the performance or the collectibility of the loans in our loan portfolios;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Material changes that may occur in the mix or in the volume of the loans in our loan portfolios that could alter, whether positively or negatively, the
risk profile of those portfolios;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in management or loan personnel or other circumstances that could, either positively or negatively, impact the application of our loan
underwriting standards, the monitoring of nonperforming loans or our loan collection efforts;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Changes in the concentration of risk in the loan portfolio; and
| | - |  | ---------------------------------------------------------------



| |  |  | External factors that, in addition to economic conditions, can affect the ability of borrowers to meet their loan obligations, such as fires,
earthquakes and terrorist attacks.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Determining the effects that these qualitative factors may have on the
performance of our loan portfolios requires numerous judgments, assumptions and estimates about conditions, trends and events which may subsequently prove to have been incorrect due to circumstances outside of our control. Moreover, the effects of
qualitative factors such as these on the performance of our loan portfolios are often difficult to quantify. As a result, we may sustain loan losses in any particular period that are sizable in relation to the Allowance or that may even exceed the
Allowance.



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In response to the economic recession, which has resulted in increased and relatively
persistent high rates of unemployment, and the credit crisis that has led to a severe tightening in the availability of credit, preventing borrowers from refinancing their loans, we have (i) implemented more stringent loan underwriting
standards, (ii) strengthened loan underwriting and approval processes and (iii) added personnel with experience in addressing problem assets.

The following table compares the total amount of loans outstanding, and the allowance for loan losses, by loan category, in each case, in thousands of dollars, and certain related ratios, as of
September 30, 2009 and June 30, 2009.



|                                        |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|--------------------------------------- |  | ----------------- | ------------------------------------ | - | ---------------- | - | ------- | ------------------- |  | - | ------- | --
|                                        |  | September 30,2009 |                                      |   | December 31,2008 |   |         | Increase/(Decrease) | 
|                                        |  |                   | December 31,2008 toSeptember 30,2009 |  
|                                        |  | As Restated(1)    |                                      |   |                  |   |         | As Restated(1)      | 
|Loan Categories:                        |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|Commercial loans                        |  | $                 | 292,757                              |   |                  | $ | 300,945 |                     |  | $ | (8,188  | ) 
|Loans impaired(2)                       |  | $                 | 24,481                               |   |                  | $ | 7,342   |                     |  | $ | 17,139  |   
|Loans 90 days past due                  |  | $                 | 15,220                               |   |                  | $ | 1,653   |                     |  | $ | 13,567  |   
|Loans 30 days past due                  |  | $                 | 3,652                                |   |                  | $ | 11,209  |                     |  | $ | (7,557  | ) 
|Allowance for loan losses               |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|General component                       |  | $                 | 5,007                                |   |                  | $ | 6,974   |                     |  | $ | (1,967  | ) 
|Specific component(2)                   |  |                   | 4,692                                |   |                  |   | 560     |                     |  |   | 4,132   |   
|                                        |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|Total allowance                         |  | $                 | 9,699                                |   |                  | $ | 7,534   |                     |  | $ | 2,165   |   
|Ratio of allowance to loan category     |  |                   | 3.31                                 | % |                  |   | 2.50    | %                   |  |   | 0.81    | % 
|                                        |  |                   |                                     
|Real estate loans:                      |  | $                 | 416,176                              |   |                  | $ | 402,668 |                     |  | $ | 13,508  |   
|Loans impaired(2)                       |  | $                 | 20,689                               |   |                  |   |        |                     |  | $ | 20,689  |   
|Loans 90 days past due                  |  | $                 | 10,049                               |   |                  |   |        |                     |  | $ | 10,049  |   
|Loans 30 days past due                  |  | $                 | 364                                  |   |                  | $ | 3,133   |                     |  | $ | (2,769  | ) 
|Allowance for loan losses               |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|General component                       |  | $                 | 6,102                                |   |                  | $ | 3,912   |                     |  | $ | 2,190   |   
|Specific component(2)                   |  |                   | 2,069                                |   |                  |   | 456     |                     |  |   | 1,613   |   
|                                        |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|Total allowance                         |  | $                 | 8,171                                |   |                  | $ | 4,368   |                     |  | $ | 3,803   |   
|Ratio of allowance to loan category     |  |                   | 1.96                                 | % |                  |   | 1.08    | %                   |  |   | 0.88    | % 
|                                        |  |                   |                                     
|Construction loans and land development |  | $                 | 54,487                               |   |                  | $ | 65,811  |                     |  | $ | (11,324 | ) 
|Loans impaired(2)                       |  | $                 | 15,008                               |   |                  | $ | 7,555   |                     |  | $ | 7,453   |   
|Loans 90 days past due                  |  | $                 | 6,030                                |   |                  | $ | 3,779   |                     |  | $ | 2,251   |   
|Loans 30 days past due                  |  | $                 | 2,215                                |   |                  | $ | 10,725  |                     |  | $ | (8,510  | ) 
|Allowance for loan losses               |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|General component                       |  | $                 | 1,858                                |   |                  | $ | 1,591   |                     |  | $ | 267     |   
|Specific component(2)                   |  |                   | 5                                    |   |                  |   | 995     |                     |  |   | (990    | ) 
|                                        |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|Total allowance                         |  | $                 | 1,863                                |   |                  | $ | 2,586   |                     |  | $ | (723    | ) 
|Ratio of allowance to loan category     |  |                   | 3.42                                 | % |                  |   | 3.93    | %                   |  |   | (0.51   | )%
|                                        |  |                   |                                     
|Consumer loans                          |  | $                 | 71,780                               |   |                  | $ | 74,300  |                     |  | $ | (2,520  | ) 
|Loans impaired(2)                       |  | $                 | 1,820                                |   |                  | $ | 3,634   |                     |  | $ | (1,814  | ) 
|Loans 90 days past due                  |  | $                 | 269                                  |   |                  | $ | 1,380   |                     |  | $ | (1,111  | ) 
|Loans 30 days past due                  |  | $                 | 1,400                                |   |                  | $ | 44      |                     |  | $ | 1,356   |   
|Allowance for loan losses               |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|General component                       |  | $                 | 601                                  |   |                  | $ | 892     |                     |  | $ | (291    | ) 
|Specific component(2)                   |  |                   | 166                                  |   |                  |   | 73      |                     |  |   | 93      |   
|                                        |  |                   |                                      |   |                  |   |         |                     |  |   |         |   
|Total allowance                         |  | $                 | 767                                  |   |                  | $ | 965     |                     |  | $ | (198    | ) 
|Ratio of allowance to loan category     |  |                   | 1.07                                 | % |                  |   | 1.30    | %                   |  |   | (0.23   | )%



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|                                              |  |   |         |   |  |   |         |   |  |   |         |  
|--------------------------------------------- |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|Total loans outstanding                       |  | $ | 835,200 |   |  | $ | 843,724 |   |  | $ | (8,524  | )
|Loans impaired(2)                             |  | $ | 61,998  |   |  | $ | 18,531  |   |  | $ | 43,467  |  
|Loans 90 days past due                        |  | $ | 31,568  |   |  | $ | 6,812   |   |  | $ | 24,756  |  
|Loans 30 days past due                        |  | $ | 7,631   |   |  | $ | 25,111  |   |  | $ | (17,480 | )
|Allowance for loan losses                     |  |   |         |   |  |   |         |   |  |   |         |  
|General component                             |  | $ | 13,568  |   |  | $ | 13,369  |   |  | $ | 199     |  
|Specific component(2)                         |  |   | 6,932   |   |  |   | 2,084   |   |  |   | 4,848   |  
|                                              |  |   |         |   |  |   |         |   |  |   |         |  
|Total allowance                               |  | $ | 20,500  |   |  | $ | 15,453  |   |  | $ | 5,047   |  
|Ratio of allowance to total loans outstanding |  |   | 2.46    | % |  |   | 1.83    | % |  |   | 0.63    | %



|(1) | See Note 2 to our unaudited Consolidated Financial Statements included elsewhere in this report.
|--- | ------------------------------------------------------------------------------------------------

|(2) | Amounts in impaired loans and in specific components include nonperforming delinquent loans.
|--- | --------------------------------------------------------------------------------------------

Set forth below is a summary, in thousands of dollars, of the transactions in the allowance for loan losses for the three and nine months
ended September 30, 2009 and the year ended December 31, 2008:



|                                           |                |                                      |        |                |                                     |   |        |                             |  |   |         |  
|------------------------------------------ | -------------- | ------------------------------------ | ------ | -------------- | ----------------------------------- | - | ------ | --------------------------- |  | - | ------- | -
|                                           |                | Three Months EndedSeptember 30, 2009 |        |                | Nine Months EndedSeptember 30, 2009 |   |        | Year EndedDecember 31, 2008 | 
|                                           | As Restated(1) |                                      |        | As Restated(1) |                                     |   |        |                            
|Balance, beginning of period               |                | $                                    | 20,442 |                |                                     | $ | 15,453 |                             |  | $ | 6,126   |  
|Provision for loan losses                  |                |                                      | 3,790  |                |                                     |   | 13,833 |                             |  |   | 21,685  |  
|Recoveries on loans previously charged off |                |                                      | 21     |                |                                     |   | 116    |                             |  |   | 80      |  
|Amounts charged off                        |                |                                      | (3,753 | )              |                                     |   | (8,902 | )                           |  |   | (12,438 | )
|                                           |                |                                      |        |                |                                     |   |        |                             |  |   |         |  
|Balance, end of period                     |                | $                                    | 20,500 |                |                                     | $ | 20,500 |                             |  | $ | 15,453  |  
|                                           |                |                                      |        |                |                                     |   |        |                             |  |   |         |  



|(1) | See Note 2 to the unaudited Consolidated Financial Statements included elsewhere in this Report.
|--- | ------------------------------------------------------------------------------------------------

The table below indicates the trend in loan delinquencies, by quarter, from September 30, 2008 to September 30, 2009.



|                                        |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|--------------------------------------- | --------------- | ---- | ---------- | ---- | ----------- | ------ | -------------- | - | --------------- |  | - | ------ |  | - | ------
|                                        |                 | 2009 |            | 2008
|                                        | At September 30 |      | At June 30 |      | At March 31 |        | At December 31 |   | At September 30
|                                        | (In thousands) 
|Loans Delinquent:                       |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|90 days or more:                        |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|Commercial loans                        |                 | $    | 15,220     |      | $           | 8,880  |                | $ | 762             |  | $ | 1,653  |  | $ | 3,920 
|Commercial real estate                  |                 |      | 10,049     |      |             | 11,724 |                |   | 3,133           |  |   |       |  |   | 6,785 
|Residential mortgages                   |                 |      | 269        |      |             | 346    |                |   | 1,166           |  |   | 1,353  |  |   | 399   
|Construction and land development loans |                 |      | 6,030      |      |             | 6,463  |                |   | 2,504           |  |   | 3,779  |  |   | 4,665 
|Consumer loans                          |                 |      |           |      |             | 17     |                |   | 27              |  |   | 27     |  |   | 78    
|                                        |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|                                        |                 |      | 31,568     |      |             | 27,430 |                |   | 7,592           |  |   | 6,812  |  |   | 15,847
|                                        |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|30-89 days:                             |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|Commercial loans                        |                 |      | 3,652      |      |             | 12,623 |                |   | 2,986           |  |   | 11,209 |  |   | 380   
|Commercial real estate                  |                 |      | 364        |      |             | 2,242  |                |   |                |  |   | 3,133  |  |   |      
|Residential mortgages                   |                 |      | 1,152      |      |             | 270    |                |   | 346             |  |   |       |  |   | 348   
|Construction and land development loans |                 |      | 2,215      |      |             |       |                |   | 6,409           |  |   | 10,725 |  |   | 7,975 
|Consumer loans                          |                 |      | 248        |      |             |       |                |   |                |  |   | 44     |  |   |      
|                                        |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|                                        |                 |      | 7,631      |      |             | 15,135 |                |   | 9,741           |  |   | 25,111 |  |   | 8,703 
|                                        |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       
|Total Past Due(1):                      |                 | $    | 39,199     |      | $           | 42,565 |                | $ | 17,333          |  | $ | 31,923 |  | $ | 24,550
|                                        |                 |      |            |      |             |        |                |   |                 |  |   |        |  |   |       



|(1) | Past due balances include nonaccrual loans.
|--- | -------------------------------------------



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Total loan past due declined by $3.4 million, or 8%, to $39.2 million at
September 30, 2009, from $42.3 million at June 30, 2009. Loans 90 days or more delinquent increased by $4.2 million, or 15%, to $31.6 million at September 30, 2009, from $27.4 million at June 30, 2009, while
loans 30 to 89 days delinquent declined by $7.5 million, or 50%, to $7.6 million at September 30, 2009, down from $15.1 million at June 30, 2009. We believe that this decline represents a positive trend which, if it continues,
could lead to a decrease in non-accrual loans during 2010. There is no assurance, however, that such a decrease will, in fact, occur, as the future direction of the economy and the speed of the economic recovery remain uncertain. Moreover, we are
not yet able to determine the extent of the impact that this trend will have on our future operating results.

Deposits

Average Balances of and Average Interest Rates Paid on Deposits.

Set forth below are the average amounts (in thousands of dollars) of, and the average rates paid on, deposits in the nine months ended
September 30, 2009:



|                                    |                |                                     |             |  |      |  
|----------------------------------- | -------------- | ----------------------------------- | ----------- |  | ---- | -
|                                    |                | Nine Months EndedSeptember 30, 2009 |            
|                                    | AverageBalance |                                     | AverageRate | 
|Noninterest-bearing demand deposits |                | $                                   | 165,709     |  |     |  
|Interest-bearing checking accounts  |                |                                     | 26,036      |  | 0.61 | %
|Money market and savings deposits   |                |                                     | 105,473     |  | 1.18 | %
|Time deposits                       |                |                                     | 604,152     |  | 3.68 | %
|                                    |                |                                     |             |  |      |  
|Average total deposits              |                | $                                   | 901,370     |  | 2.63 | %
|                                    |                |                                     |             |  |      |  

Deposit Totals. Deposits totaled $858 million at September 30, 2009 as compared to
$822 million at December 31, 2008. At September 30, 2009, noninterest-bearing deposits totaled $179 million and represented 21% of total deposits, as compared to $152 million and 19% of total deposits at December 31, 2008. At
September 30, 2009, certificates of deposit in denominations of $100,000 or more totaled $384 million and represented 45% of total deposits, as compared to $326 million and 40% of total deposits at December 31, 2008. Due to the
deterioration of the economy and continuing uncertainties as to the ultimate severity and duration of the economic recession and credit crisis, we decided to increase the Banks liquidity by increasing the volume of the time certificates of
deposits in the first half of 2009, the proceeds of which were used primarily to reduce long term borrowings and to fund increases in loans and short-term interest-earning assets. During the third quarter of 2009, we were able to decrease the volume
of our time deposits by $81 million to $549 million from $630 million at June 30, 2009, by replacing the cash provided by those deposits with cash from the sale of securities available for sale.

Set forth below, in thousands of dollars, is a maturity schedule of domestic time certificates of deposit outstanding at September 30,
2009:



|                                     |                                     |                       |                                          |  |   |        
|------------------------------------ | ----------------------------------- | --------------------- | ---------------------------------------- |  | - | -------
|                                     |                                     | At September 30, 2009
|                                     | Certificatesof DepositUnder$100,000 |                       | Certificatesof Depositof $100,000or More
|Maturities                           |                                     |                       |                                          |  |   |        
|Three months or less                 |                                     | $                     | 60,893                                   |  | $ | 189,793
|Over three and through twelve months |                                     |                       | 76,820                                   |  |   | 143,110
|Over twelve months                   |                                     |                       | 27,569                                   |  |   | 50,600 
|                                     |                                     |                       |                                          |  |   |        
|Total certificates of deposit        |                                     | $                     | 165,282                                  |  | $ | 383,503
|                                     |                                     |                       |                                          |  |   |        

Liquidity

We actively manage our liquidity needs to ensure that sufficient funds are available to meet our needs for cash, including to fund new loans
to and deposit withdrawals by our customers. We project the future sources and uses of funds and maintain liquid funds for unanticipated events. Our primary sources of cash include cash we have on deposit



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at other financial institutions, payments on loans, proceeds from the sale or maturity of securities, and from sales of residential mortgage loans, increases in deposits and increases in
borrowings principally from the Federal Home Loan Bank. The primary uses of cash include funding new loans and making advances on existing lines of credit, purchasing investments, including securities available for sale, funding new residential
mortgage loans, funding deposit withdrawals and paying operating expenses. We maintain funds in overnight federal funds and other short-term investments to provide for short-term liquidity needs. We also have obtained credit lines from the Federal
Home Loan Bank and other financial institutions to meet any additional liquidity requirements.

Our liquid assets, which
included cash and due from banks, federal funds sold, interest earning deposits with financial institutions and unpledged securities available for sale (excluding Federal Reserve Bank and Federal Home Loan Bank stock) totaled $127 million, which
represented 11.5% of total assets, at September 30, 2009.

Cash Flow Used in Operating Activities. We used net
cash flow of $16.7 million from operating activities primarily to fund the net loss of $8.6 million in the nine months ended September 30, 2009, and to fund the origination of $39.1 million of mortgage loans, partially offset by $28.9 million
in proceeds on sales of mortgage loans.

Cash Flow Provided by Investing Activities. In the nine months ended
September 30, 2009, investing activities provided net cash of $46.5 million, comprised of cash from sales of securities available for sale totaling $187.7 million, $12 million received from maturities and interest on securities
available for sale, substantially offset by purchases of a total of $136.6 million of securities available for sale and purchases by us of $16.6 million in time deposits at other financial institutions.

Cash Flow Used by Financing Activities. We used net cash flow of $45.9 million in financing activities during the nine months ended
September 30, 2009, to fund a net decrease of $81.8 million in borrowings, partially offset by a net increase of $35.9 million in deposits.

Ratio of Loans to Deposits. The relationship between gross loans and total deposits can provide a useful measure of a banks liquidity. Since repayment of loans tends to be less predictable
than the maturity of investments and other liquid resources, the higher the loan-to-deposit ratio the less liquid are our assets. On the other hand, since we realize greater yields on loans than we do on investments, a lower loan-to-deposit ratio
can adversely affect interest income and earnings. As a result, our goal is to achieve a loan-to-deposit ratio that appropriately balances the requirements of liquidity and the need to generate a fair return on assets. At September 30, 2009 and
December 31, 2008, the ratios of loans-to-deposits were 95% and 101%, respectively. The reduction in that ratio at September 30, 2009, as compared to December 31, 2008, was primarily attributable to our decision to increase our
liquidity, which we believe was prudent due to the continuing economic recession and credit crisis and uncertainties as to their ultimate duration.

Off Balance Sheet Arrangements

Loan Commitments and Standby
Letters of Credit. In order to meet the financing needs of our customers, in the normal course of business we make commitments to extend credit and issue standby commercial letters of credit to or for our customers. At September 30, 2009
and December 31, 2008, we were committed to fund certain loans, including letters of credit, amounting to approximately $216 million and $218 million, respectively.

Commitments to extend credit and standby letters of credit generally have fixed expiration dates or other termination clauses and the
customer may be required to pay a fee and meet other conditions in order to draw on those commitments or standby letters of credit. We expect, based on historical experience, that many of the commitments will expire without being drawn upon and,
therefore, the total commitment amounts do not necessarily represent future cash requirements.

To varying degrees,
commitments to extend credit involve elements of credit and interest rate risk for us that are in excess of the amounts recognized in our balance sheets. Our maximum exposure to credit loss in the event of nonperformance by the customers to whom
such commitments are made could potentially be equal to the amount of those commitments. As a result, before making such a commitment to a customer, we evaluate the customers creditworthiness using the same underwriting standards that we would
apply if we were approving loans to the customer. In addition, we often require the customer to secure its payment obligations for amounts drawn on such commitments with collateral such as accounts receivable, inventory, property, plant and
equipment, income-producing



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commercial properties, residential properties and properties under construction. As a consequence, our exposure to credit and interest rate risk on such commitments is not different in character
or amount than risks inherent in the outstanding loans in our loan portfolio.

Standby letters of credit are conditional
commitments issued by the Bank to guarantee a payment obligation of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

We believe that our cash and cash equivalent resources, together with available borrowings under our credit facilities, will be
sufficient to enable us to meet any increases in demand for loans or in the utilization of outstanding loan commitments or standby letters of credit and any increase in deposit withdrawals that might occur in the foreseeable future.

Contractual Obligations

Borrowings. As a source of additional funds that we have used primarily to fund loans and to purchase other interest earning assets, and to provide us with a supplemental source of liquidity, we
have obtained long and short term borrowings from the Federal Home Loan Bank (the FHLB). As of September 30, 2009, we had $17 million of outstanding long-term borrowings, with maturities in December 2010, and $135 million of
outstanding short-term borrowings, with maturities ranging from November 2009 to June 2010 that we had obtained from the Federal Home Loan Bank. These borrowings have a weighted-average annualized interest rate of 4.11%. By comparison, as of
December 31, 2008, we had $121 million of outstanding long-term borrowings and $104 million of outstanding short-term borrowings that we had obtained from the Federal Home Loan Bank, which, together with the securities sold under
agreements to repurchase, had a weighted-average annualized interest rate of 3.78%.

At September 30, 2009, U.S. agency
and mortgage backed securities, U.S. Government agency securities, collateralized mortgage obligations and time deposits with an aggregate fair market value of $98 million and $188 million of residential mortgage and other real estate
secured loans were pledged to secure these Federal Home Loan Bank borrowings, repurchase agreements, local agency deposits, and treasury, tax and loan accounts.

The highest amount of borrowings that were outstanding at any month-end during the nine months ended September 30, 2009 consisted of $208 million of borrowings from the Federal Home Loan Bank
and $13 million of overnight borrowings in the form of securities sold under repurchase agreements. During 2008, the highest amount of borrowings outstanding at any month-end consisted of $236 million of advances from the Federal Home Loan
Bank and $13 million of overnight borrowings in the form of securities sold under repurchase agreements.

Junior
Subordinated Debentures. Pursuant to rulings of the Federal Reserve Board, bank holding companies are permitted to issue long term subordinated debt instruments that will, subject to certain conditions, qualify as and, therefore, augment capital
for regulatory purposes. At September 30, 2009, we had outstanding approximately $17.5 million principal amount of 30-year junior subordinated floating rate debentures (the Debentures). The Debentures are redeemable at our option,
without premium or penalty, beginning five years after their respective original issue dates, and require quarterly interest payments. Subject to certain conditions, we have the right, at our discretion, to defer those interest payments for up to
five years. However, we do not have any present plans to exercise this deferral right.

Set forth below is certain information
regarding the terms of the Debentures that remained outstanding as of September 30, 2009:



|                     |                |                  |        |                |                 |   |                |               
|-------------------- | -------------- | ---------------- | ------ | -------------- | --------------- | - | -------------- | --------------
|Original Issue Dates |                | Principal Amount |        | Interest Rates |                 |   | Maturity Dates
|                     | (In thousands) |                  |        |                |                 |  
|September 2002       |                | $                | 7,217  |                | LIBOR plus 3.40 | % |                | September 2032
|October 2004         |                |                  | 10,310 |                | LIBOR plus 2.00 | % |                | October 2034  
|                     |                |                  |        |                |                 |   |                |               
|Total                |                | $                | 17,527 |                |                 |   |                |               
|                     |                |                  |        |                |                 |   |                |               

Under the Federal Reserve Board rulings, the borrowings evidenced by the Debentures, which are
subordinated to all of our other borrowings that are outstanding or which we may obtain in the future, are eligible (subject to certain dollar limitations) to qualify, and at September 30, 2009, all $17.5 million principal amount of those
Debentures qualified, as Tier I capital for regulatory purposes. See discussion below under the subcaption Capital Resources-Regulatory Capital Requirements.



41



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Investment Policy and Securities Available for Sale

Our investment policy is designed to provide for our liquidity needs and to generate a favorable return on investments without undue interest
rate risk, credit risk or asset concentrations.

Our investment policy:



| |  |  | authorizes us to invest in obligations issued or fully guaranteed by the United States Government, certain federal agency obligations, time deposits
issued by federally insured depository institutions, municipal securities and in federal funds sold;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provides that the weighted average maturities of U.S. Government obligations and federal agency securities cannot exceed 10 years and municipal
obligations cannot exceed 25 years;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provides that time deposits must be placed with federally insured financial institutions, cannot exceed the current federally insured amount in any one
institution and may not have a maturity exceeding 60 months, unless that time deposit is matched to a liability instrument issued by the Bank; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | prohibits engaging in securities trading activities.
| | - |  | ----------------------------------------------------

Securities available for sale are those that we intend to hold for an indefinite period of time, but which may be sold in response to changes in liquidity needs, changes in interest rates, changes in
prepayment risks or other similar factors. Such securities are recorded at fair value. Any unrealized gains and losses are reported as Other Comprehensive Income (Loss) rather than included in or deducted from earnings.



42



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##### Table of Contents

The following is a summary of the major components of securities available for sale and a
comparison of the amortized cost, estimated fair values and gross unrealized gains and losses, in thousands of dollars, as of September 30, 2009 and December 31, 2008:



|                                                                      |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|--------------------------------------------------------------------- |  | ------------- | ------- | ------------------- | - | ------------------- |  | - | ------------------- | - |  | - | -------
|                                                                      |  | AmortizedCost |         | GrossUnrealizedGain |   | GrossUnrealizedLoss |  |   | EstimatedFair Value
|September 30, 2009                                                    |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Securities Available For Sale:                                        |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|US Treasury securities                                                |  | $             | 72,843  |                     | $ | 133                 |  | $ |                    |   |  | $ | 72,976 
|Mortgage-backed securities issued by US agencies                      |  |               | 12,457  |                     |   | 65                  |  |   | (67                 | ) |  |   | 12,455 
|Collateralized mortgage obligations issued by US agencies             |  |               | 6,829   |                     |   |                    |  |   | (43                 | ) |  |   | 6,786  
|                                                                      |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total securities issued or guaranteed by US government or US agencies |  |               | 92,129  |                     |   | 198                 |  |   | (110                | ) |  |   | 92,217 
|Municipal securities                                                  |  |               | 14,180  |                     |   | 149                 |  |   | (182                | ) |  |   | 14,147 
|Non-agency collateralized mortgage obligations                        |  |               | 7,704   |                     |   |                    |  |   | (1,337              | ) |  |   | 6,367  
|Asset-backed securities                                               |  |               | 2,737   |                     |   |                    |  |   | (1,277              | ) |  |   | 1,460  
|Mutual fund                                                           |  |               | 2,292   |                     |   |                    |  |   |                    |   |  |   | 2,292  
|                                                                      |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total Securities Available For Sale                                   |  | $             | 119,042 |                     | $ | 347                 |  | $ | (2,906              | ) |  | $ | 116,483
|                                                                      |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|                                                                      |  |               |         |                    
|December 31, 2008                                                     |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Securities Available For Sale:                                        |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|US agencies and mortgage-backed securities                            |  | $             | 126,065 |                     | $ | 1,538               |  | $ | (471                | ) |  | $ | 127,132
|Collateralized mortgage obligations                                   |  |               | 425     |                     |   | 4                   |  |   |                    |   |  |   | 429    
|                                                                      |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total government and agencies securities                              |  |               | 126,490 |                     |   | 1,542               |  |   | (471                | ) |  |   | 127,561
|Municipal securities                                                  |  |               | 22,895  |                     |   | 90                  |  |   | (1,523              | ) |  |   | 21,462 
|Non-agency collateralized mortgage obligations                        |  |               | 10,278  |                     |   |                    |  |   | (1,340              | ) |  |   | 8,938  
|Asset backed securities                                               |  |               | 1,237   |                     |   |                    |  |   |                    |   |  |   | 1,237  
|Mutual fund                                                           |  |               | 1,747   |                     |   |                    |  |   |                    |   |  |   | 1,747  
|                                                                      |  |               |         |                     |   |                     |  |   |                     |   |  |   |        
|Total Securities Available For Sale                                   |  | $             | 162,647 |                     | $ | 1,632               |  | $ | (3,334              | ) |  | $ | 160,945
|                                                                      |  |               |         |                     |   |                     |  |   |                     |   |  |   |        

At September 30, 2009, U.S. agencies and mortgage
backed securities, U.S. Government agency securities, collateralized mortgage obligations and time deposits with an aggregate fair market value of $108 million were pledged to secure Federal Home Loan Bank borrowings, repurchase agreements, local
agency deposits, to secure lines of credit at our correspondent banks and treasury, tax and loan accounts.



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##### Table of Contents

The amortized cost, at September 30, 2009, of securities available for sale are shown,
in thousands of dollars, in the following table, by contractual maturities and historical prepayments based on the prior three months of principal payments. Expected maturities will differ from contractual maturities and historical prepayments,
particularly with respect to collateralized mortgage obligations, because borrowers may react to interest rate market conditions differently than the historical prepayment rates.



|                                               |                        |                               |                      |                                |      |           |                                 |                      |        |               |           |   |                      |   |       |           |      |                      |  |   |           |  |                      |   |  |   |         |  |      |  
|---------------------------------------------- | ---------------------- | ----------------------------- | -------------------- | ------------------------------ | ---- | --------- | ------------------------------- | -------------------- | ------ | ------------- | --------- | - | -------------------- | - | ----- | --------- | ---- | -------------------- |  | - | --------- |  | -------------------- | - |  | - | ------- |  | ---- | -
|                                               |                        | September 30, 2009Maturing in |                     
|                                               | One yearor less        |                               |                      | Over oneyear throughfive
years |      |           | Over fiveyears throughten
years |                      |        | Over tenyears |           |   | Total                |  
|                                               | BookValue              |                               | WeightedAverageYield |                                |      | BookValue |                                 | WeightedAverageYield |        |               | BookValue |   | WeightedAverageYield |   |       | BookValue |      | WeightedAverageYield |  |   | BookValue |  | WeightedAverageYield |  
|                                               | (Dollars in thousands) |                              
|Securities available for sale:                 |                        |                               |                      |                                |      |           |                                 |                      |        |               |           |   |                      |   |       |           |      |                      |  |   |           |  |                      |   |  |   |         |  |      |  
|US Treasury securities                         |                        | $                             | 72,843               |                                | 0.49 | %         |                                 | $                    |       |               |          |   |                      | $ |      |           |     |                      |  | $ |          |  |                     |   |  | $ | 72,843  |  | 0.49 | %
|US agency/mortgage- backed securities          |                        |                               | 3,805                |                                | 2.36 | %         |                                 |                      | 4,737  |               | 2.99      | % |                      |   | 1,739 |           | 3.72 | %                    |  |   | 2,176     |  | 4.10                 | % |  |   | 12,457  |  | 3.10 | %
|Agency collateralized mortgage obligations     |                        |                               |                     |                                |     |           |                                 |                      |       |               |          |   |                      |   | 2,980 |           | 4.81 | %                    |  |   | 3,849     |  | 4.81                 | % |  |   | 6,829   |  | 4.81 | %
|Non-agency collateralized mortgage obligations |                        |                               | 1,421                |                                | 4.75 | %         |                                 |                      | 4,765  |               | 4.46      | % |                      |   | 1,518 |           | 4.38 | %                    |  |   |          |  |                     |   |  |   | 7,704   |  | 6.49 | %
|Municipal securities                           |                        |                               |                     |                                |     |           |                                 |                      |       |               |          |   |                      |   | 1,349 |           | 4.10 | %                    |  |   | 12,831    |  | 4.26                 | % |  |   | 14,180  |  | 4.24 | %
|Asset backed securities                        |                        |                               |                     |                                |     |           |                                 |                      |       |               |          |   |                      |   |      |           |     |                      |  |   | 2,737     |  | 1.18                 | % |  |   | 2,737   |  | 1.18 | %
|Mutual funds                                   |                        |                               |                     |                                |     |           |                                 |                      | 2,292  |               | 4.00      | % |                      |   |      |           |     |                      |  |   |          |  |                     |   |  |   | 2,292   |  | 4.00 | %
|                                               |                        |                               |                      |                                |      |           |                                 |                      |        |               |           |   |                      |   |       |           |      |                      |  |   |           |  |                      |   |  |   |         |  |      |  
|Total Securities Available for sale            |                        | $                             | 78,069               |                                | 0.66 | %         |                                 | $                    | 11,794 |               | 3.78      | % |                      | $ | 7,586 |           | 4.48 | %                    |  | $ | 21,593    |  | 3.95                 | % |  | $ | 119,042 |  | 1.81 | %
|                                               |                        |                               |                      |                                |      |           |                                 |                      |        |               |           |   |                      |   |       |           |      |                      |  |   |           |  |                      |   |  |   |         |  |      |  

The table below shows, as of September 30, 2009, the gross unrealized losses and fair values (in
thousands of dollars) of our investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.



|                                               |                     |                                                         |                |                   |   |            |       |                |   |        |            |   |                |   |  |   |        |  |   |        |  
|---------------------------------------------- | ------------------- | ------------------------------------------------------- | -------------- | ----------------- | - | ---------- | ----- | -------------- | - | ------ | ---------- | - | -------------- | - |  | - | ------ |  | - | ------ | -
|(Dollars In thousands)                         |                     | Securities With Unrealized Loss as ofSeptember 30, 2009 |               
|                                               | Less than 12 months |                                                         |                | 12 months or more |   |            | Total |               
|                                               | Fair Value          |                                                         | UnrealizedLoss |                   |   | Fair Value |       | UnrealizedLoss |   |        | Fair Value |   | UnrealizedLoss |  
|US agency mortgage backed securities           |                     | $                                                       | 1,630          |                   | $ | (19        | )     |                | $ | 4,163  |            | $ | (48            | ) |  | $ | 5,793  |  | $ | (67    | )
|Agency collateralized mortgage obligations     |                     |                                                         | 6,786          |                   |   | (43        | )     |                |   |       |            |   |               |   |  |   | 6,786  |  |   | (43    | )
|Non agency collateralized mortgage obligations |                     |                                                         | 2,677          |                   |   | (78        | )     |                |   | 3,690  |            |   | (1,259         | ) |  |   | 6,367  |  |   | (1,337 | )
|Asset backed securities                        |                     |                                                         |               |                   |   |           |       |                |   | 1,460  |            |   | (1,277         | ) |  |   | 1,460  |  |   | (1,277 | )
|Municipal securities                           |                     |                                                         |               |                   |   |           |       |                |   | 4,081  |            |   | (182           | ) |  |   | 4,081  |  |   | (182   | )
|                                               |                     |                                                         |                |                   |   |            |       |                |   |        |            |   |                |   |  |   |        |  |   |        |  
|Total temporarily impaired securities          |                     | $                                                       | 11,093         |                   | $ | (140       | )     |                | $ | 13,394 |            | $ | (2,766         | ) |  | $ | 24,487 |  | $ | (2,906 | )
|                                               |                     |                                                         |                |                   |   |            |       |                |   |        |            |   |                |   |  |   |        |  |   |        |  

We regularly monitor investments for significant declines in fair value. In our judgment, the declines in
the fair values of these investments below their amortized costs, as set forth in the table above, are temporary, based on the following factors: (i) those declines are due to interest rate changes and not due to a deterioration in the
creditworthiness of the issuers of those investment securities, and (ii) we have the ability to hold those securities until there is a recovery in their values or until their maturity.



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Capital Resources

Capital Regulatory Requirements Applicable to Banking Institutions. Under federal banking regulations that apply to all United States
based bank holding companies and federally insured banks, the Company (on a consolidated basis) and the Bank (on a stand-alone basis) must meet specific capital adequacy requirements that, for the most part, involve quantitative measures, primarily
in terms of the ratios of their capital to their assets, and liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Under those regulations, based primarily on those quantitative measures each bank holding
company must meet a minimum capital ratio and each federally insured bank is determined by its primary federal bank regulatory agency to come within one of the following categories.



| |  |  | well capitalized
| | - |  | ----------------



| |  |  | adequately capitalized
| | - |  | ----------------------



| |  |  | undercapitalized
| | - |  | ----------------



| |  |  | significantly undercapitalized; or
| | - |  | ----------------------------------



| |  |  | critically undercapitalized
| | - |  | ---------------------------

Certain qualitative assessments also are made by a banking institutions primary federal regulatory agency that could lead the agency to determine that a banking institution should be assigned to a
lower capital category than the one indicated by the quantitative measures used to assess the institutions capital adequacy. At each successive lower capital category, a banking institution is subject to greater operating restrictions and
increased regulatory supervision by its federal bank regulatory agency.

The following table sets forth the capital and
capital ratios of the Company (on a consolidated basis) and the Bank (on a stand-alone basis) at September 30, 2009, as compared to the respective minimum regulatory requirements applicable to them.



|                                        |                        |   |        |                              |      |        |                                                   |       |                |  |              |   |       |   |        |  |               |  
|--------------------------------------- | ---------------------- | - | ------ | ---------------------------- | ---- | ------ | ------------------------------------------------- | ----- | -------------- |  | ------------ | - | ----- | - | ------ |  | ------------- | -
|                                        |                        |   |        |                              |      |        | Applicable Minimum Federal Regulatory Requirement |      
|                                        | Actual                 |   |        | For Capital AdequacyPurposes |      |        | To be Categorized WellCapitalized                 |      
|                                        | Amount                 |   | Ratio  |                              |      | Amount |                                                   | Ratio |                |  | Amount       |   | Ratio |  
|                                        | (Dollars in thousands) |  
|                                        | As Restated(1)         |   |        | As Restated(1)               |      |        |                                                   |       | As Restated(1) |  |              |  
|Total Capital to Risk Weighted Assets:  |                        |   |        |                              |      |        |                                                   |       |                |  |              |   |       |   |        |  |               |  
|Company                                 |                        | $ | 99,242 |                              | 11.0 | %      |                                                   | $     | 71,955         |  | At least 8.0 | % |       |   | N/A    |  | N/A           |  
|Bank                                    |                        |   | 96,003 |                              | 10.7 | %      |                                                   |       | 71,856         |  | At least 8.0 | % |       | $ | 89,819 |  | At least 10.0 | %
|Tier 1 Capital to Risk Weighted Assets: |                        |   |        |                              |      |        |                                                   |       |                |  |              |   |       |   |        |  |               |  
|Company                                 |                        | $ | 87,882 |                              | 9.8  | %      |                                                   | $     | 35,978         |  | At least 4.0 | % |       |   | N/A    |  | N/A           |  
|Bank                                    |                        |   | 84,658 |                              | 9.4  | %      |                                                   |       | 35,928         |  | At least 4.0 | % |       | $ | 53,892 |  | At least 6.0  | %
|Tier 1 Capital to Average Assets:       |                        |   |        |                              |      |        |                                                   |       |                |  |              |   |       |   |        |  |               |  
|Company                                 |                        | $ | 87,882 |                              | 7.4  | %      |                                                   | $     | 47,294         |  | At least 4.0 | % |       |   | N/A    |  | N/A           |  
|Bank                                    |                        |   | 84,658 |                              | 7.2  | %      |                                                   |       | 47,159         |  | At least 4.0 | % |       | $ | 58,949 |  | At least 5.0  | %



|(1) | These amounts and percentages have been restated. See Note 2 to the unaudited Consolidated Financial Statements included elsewhere in this report.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

At September 30, 2009 the Bank (on a stand-alone basis) continued to qualify as a well-capitalized
institution, and the Company continued to exceed the minimum required capital ratios, under the capital adequacy guidelines described above. During the nine months ended September 30, 2009, the Company made a $16.0 million capital
contribution to the Bank to offset decline in the Banks capital due to the losses incurred during that period and to better enable the Bank to absorb any additional loan losses that could occur as a result of economic and financial crisis in
the United States and, at the same time, maintain its capital ratios above those required to qualify as a well capitalized banking institution for regulatory purposes.

The consolidated total capital and Tier 1 capital of the Company, at September 30, 2009, include an aggregate of $17.5 million principal amount of Junior Subordinated Debentures that we
issued in 2002 and 2004. We contributed that amount to the Bank over a six year period ended December 31, 2008, thereby providing it with additional cash to fund the growth of its banking operations and, at the same time, to increase its total
capital and Tier 1 capital.



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##### Table of Contents

As previously reported in a Current Report filed with the SEC on Form 8-K dated
October 6, 2009, we have commenced a private offering, to a limited number of accredited investors (as defined in Regulation D under the Securities Act of 1933, as amended), of up to $15.5 million of a new issue of Series A Convertible 10%
Cumulative Preferred Stock (the Series A Shares). Cumulative dividends will accrue on the Series A Shares at a rate of 10% per annum. Each Series A Share will be convertible at the option of its holder, at a conversion price of
$7.65 per share, into approximately 13.07 shares of our common stock and, if not sooner converted, all of the Series A Shares will automatically convert into common stock at that same conversion price (as the same may be adjusted under certain
anti-dilution provisions applicable to the Series A Shares) on the second anniversary of the original issue date of the Series A Shares (subject to a possible deferral of that automatic conversion date). A more detailed description of the
rights, preferences and privileges of and restrictions of the Series A Shares is contained in that Current Report on Form 8-K and the foregoing summary is qualified by reference to that description.

We expect to use the proceeds from the sale of the Series A Shares for general corporate purposes, which will include making a capital
contribution to Bank in order to increase its equity capital and to provide it with cash to fund additional loans and other interest-earning assets and meet working capital requirements.

The private offering is being made by us on a best efforts basis and we are not able, at this time, to make a prediction as to the amount of
the Series A Shares that will be sold in the offering.

Dividend Policy. It continues to be the policy of the Board to
retain earnings to support future growth and, at the present time, there are no plans to declare any cash dividends and it is unlikely that any dividends will be declared at least until economic conditions improve, we see a reduction in
non-performing assets and the Company returns to profitability. Thereafter, the Board of Directors may consider the advisability of paying cash dividends. Any such decision will be based on a number of factors, including the Companys recent
and then expected future financial performance, its available cash and capital resources and any competing needs for capital or cash that the Company or the Bank may have. Moreover we will need to obtain the approval of the Federal Reserve Bank for
any cash dividend we propose to pay. See Item 1A in Part II of this Report for a description of that requirement.

Share Repurchase Programs. In September 2005 and again in October 2008, our Board of Directors approved share repurchase programs because the Board had concluded that, at their then prevailing market prices, the Companys shares
represented an attractive investment opportunity that made share repurchases a good use of Company funds.

Those programs
provided that any share purchases would be made in the open market or in private transactions, in accordance with applicable Securities and Exchange Commission rules, when opportunities became available to purchase shares at prices believed to be
attractive. We are under no obligation to repurchase any shares under either of these programs and the timing, actual number and value of shares that we may repurchased under these programs will depend on a number of factors, including our recent
and future financial performance and available cash resources, competing uses for our corporate funds, prevailing market prices of our common stock and the number of shares that become available for sale at prices that we believe are attractive, as
well as any regulatory requirements applicable to the Company.

These share repurchase programs do not have expiration dates.
However, we may elect (i) to suspend share repurchases at any time or from time to time, or (ii) to terminate the programs prior to the repurchase of all of the shares authorized for repurchase under these programs. Between September 2005
and December 2008, we repurchased a total of 148,978 of our shares. No shares have been repurchased since December 2008 and there is no assurance that any additional shares will be repurchased under these programs.

Since share repurchases have the effect of reducing capital, we do not expect to make any significant share repurchases at least until
economic and financial conditions improve, we see a reduction in nonperforming assets and the Company returns to profitability. Moreover, as is the case with cash dividends, we will need to obtain the approval of the Federal Reserve Bank and
California Department of Financial Institutions to repurchase additional shares under these programs.



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##### Table of Contents

|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the
SECs rules and forms, and that such information is accumulated and communicated to management, including our CEO and CFO, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and
procedures, our management recognized that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management
necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

In accordance with SEC rules, an evaluation was performed under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer of the effectiveness, as of September 30, 2009, of the Companys
disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon that evaluation, we concluded that our disclosure controls and procedures were not effective as of September 30, 2009. Our conclusion was
primarily related to the methodologies we used to assess the adequacy of the allowance for loan losses, and, corresponding, the amount of the provision we made for loans losses, at September 30, 2009. We concluded that those methodologies
relied too heavily on quantitative, and did not take full account of qualitative, measures in determining the adequacy of the allowance for loan losses.

Changes in Internal Control over Financial Reporting

On January 29,
2010, the Company determined that it was necessary to restate its previously issued unaudited consolidated financial statements as of and for the three and nine months ended September 30, 2009 and, for that reason, those consolidated financial
statements should no longer be relied upon. As is described in the Explanatory Note to this Amendment No. 1 on Form 10-Q/A, the restatement was the result of a determination that greater weight should have been given to qualitative reserve factors
in determining the allowance for loan losses at September 30, 2009.

In connection with that restatement, management
reassessed, and identified a material weakness in, the Companys internal control over financial reporting. A material weakness is defined as a control deficiency, or combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. That material weakness involved an under-weighting of qualitative reserve factors, such as the continuing economic recession
and, in particular, the high unemployment rates in California, in determining the amount of the allowance for loan losses, which resulted in a material misstatement in the previously reported amount of that allowance as of September 30, 2009.

Remediation

In order to address and correct the material weakness identified above, our management has modified its policies and procedures for assessing the adequacy of the Companys allowance for loan losses
to give greater weight to the impact that qualitative factors, such as those described earlier in this report, can reasonably be expected to have on the performance and collectibility of loans in our loan portfolio. See Item
2MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSNonperforming Loans and Allowance for Loan Losses.

There were no changes in our internal control over financial reporting, other than those described above, during the three months ended September 30, 2009 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.



|ITEM 6. | EXHIBITS
|------- | --------

The following
documents are filed as Exhibits to the Quarterly Report on Form 10-Q/A:



|             |  |                                                                                             
|------------ |  | --------------------------------------------------------------------------------------------
|Exhibit No.  |  | Description of Exhibit                                                                      
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.1 |  | Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.2 |  | Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002



47



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment No. 1 to Quarterly
Report on Form 10-Q/A to be signed on its behalf by the undersigned thereunto duly authorized.



|                     |  |                            |  |                        
|-------------------- |  | -------------------------- |  | -----------------------
|                     |  | PACIFIC MERCANTILE BANCORP
|                     |  |                           
|Date: March 16, 2010 |  | By:                        |  | /S/    NANCY A.
GRAY   
|                     |  |                            |  | Nancy A. Gray,         
|                     |  |                            |  | Chief Financial Officer



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##### Table of Contents

EXHIBIT INDEX



|             |  |                                                                                             
|------------ |  | --------------------------------------------------------------------------------------------
|Exhibit No.  |  | Description of Exhibit                                                                      
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.1 |  | Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.2 |  | Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002



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